THE WORLD BANK OPERATIONS EVALUATION DEPARTMENT                                                            JBD
23737
The World Bank, Privatization and
Enterprise Reform in Transition
Economies:
A Retrospective Analysis
John Nellis
Center for Global Development
Washington, D.C.
Director-General, Operations Evaluation: Robert Picciotto
Director: Gregory Ingram
Manager: Ruben Lamdany
Task Manager: Alice Galenson
Staff member in the World Bank from 1984 to 2000.                                           2002
Hany Broadman. Simeon Djankov, Bernard Drum, Oleh Havrylyshyn, Janos              The World Bank
Komai, Lars Jeurling. Michael Lav, Peter Murrell, Roberto Rocha and Herbert     Washington, D. C.   UVA
Schmidt offered comments on a first draft that led to changes. Alex Kuo prepared
the bibliography. Remaining errors are the author's.



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http:/www.worldbank.org/oed
2



Contents
This conceptual account details the approach to privatization and enterprise reform of
three major countries in transition: Poland, Russia, and the Czech Republic and Slovakia.
It discusses the states of mind that prevailed in each country, the perceptions of the World
Bank at various places and moments, the initial conditions faced by reformers and those
who assisted them, and the policy frameworks that evolved.
*  Bank thinking on public enterprise reform and privatization prior to its
large-scale involvement in transition: It was thought that there was no need to
break conglomerates up because import competition would prevent abuses of
market power-and that new owners would lobby for further liberalizing reforms
and for supporting institutions.
*  Original moments of contact: Changes were enormnous in scope, lightning-like
in speed.
*  Poland: a very slow privatizer
*  Czechoslovakia: mass privatization through vouchers
*  Russia: special and complex
*  What works and what doesn't: Concentrated owners far outperform diffuse
owners; institutions make the difference in that outperformance.
*  Conclusions






Policy summary
The speedy, astonishing collapse of communism demonstrated that one had entered a
period of "extraordinary politics." It was easy to conclude that this was also a period of
"extraordinary economics"-that one could:
*  Privatize conglomerates without breaking them up and assume that import
competition would prevent the abuse of market power (without thinking too much
about structural barriers to imports from exchange rate issues, poor transportation
systems, and activist and often corrupt sub-national governments that moved to
protect "their" firms from competition of any sort).
* Assign the primary restructuring and corporate governance responsibilities to
second-phase private owners (and downplay the absent or very weak mechanisms
that would make it feasible and worthwhile for this secondary trading to take
place).
*  Depend on a mass of brand new and often bewildered and suspicious private
shareholders to lobby for further liberalizing reforms and supporting institutions
(without noting that there was not much historical evidence of a "demand-pull"
causation sequence for institutions).
In many cases privatization could have-and probably should have-been better
managed, and opportunities were missed. But it is inaccurate and unfair to hold
privatization accountable for all the problems of transition. First, the evidence shows that
in East and Central Europe, privatization has proven its worth. Second, even in the
former Soviet Union, most early reformers were careful to state that the first objective of
privatization was to depoliticize the links between enterprises and the state; they accepted
that efficiency and equity considerations had to come later. They were especially
convinced there was a need for speed; one had to act quickly to forestall the return of the
communists.
A change of ownership by itself was not sufficient to cut the political-financial links.
But that was not clear at the outset-and it still looks like a necessary condition. It also is
now clear that far more time was available than had been thought. "It might have been
possible to approach privatization in a more deliberate manner; the results might have
been less insider ownership and domination, less resistance to external investors, more
protection for minority shareholders." This may be the case. But again, counter to this
speculation is the fact that countries in the former Soviet Union that pursued an alternate
path-of trying to transit without much change of ownership-have not had any great
success.
A unifying thread in Poland, Czechoslovakia, and Russia is the importance of
establishing control over managers. Managers were the group that emerged from the
wreckage of central planning best placed to further their interests. Methods and policies
that established rules and surveillance, that opened the doors to foreign investors (who
were subject to some extra-national reviews of and limits on their behavior), that pushed
competition and freer entry and exit alongside change of ownership, proved better, both
in promoting restructuring in the firms and in gaining public acceptance of the process.



Faith in the voucher approach was misplaced-or at least too heavily
overemphasized. We-the Bank-should have been searching earlier for ways to
introduce concentrated owners; we should have paid more attention (earlier than we did)
to prudential regulations in capital and financial markets and other institutional
development matters. Note that these were not ignored; but the relative effort devoted to
these activities was small in comparison to the push for mass privatization.
The use of vouchers might have been limited to minority stakeholders. Specifically,
the Bank might have done better to advocate more widely the approach used by the
Estonians: that is, limiting the exchange of vouchers to minority stakes in firms in which
a controlling majority share had already been sold to a core investor. This. increases the
chances of turning over the firm to a good owner, possessing the incentives to look after
and develop the health of the assets. It also increases the chances that voucher holders
will obtain a share that will maintain or increase its value. Indeed, the Estonians applied
this procedure in a small number of the higher potential firns, further increasing the
prospects for the new minority shareholders. The counter argument is that Estonia was a
special case with conditions that could not easily be replicated-and that elsewhere core
investors could not so readily have been found. But this use of vouchers would have been
worth a try, particularly in Russia, at least for a set of firms.



2
I - Introduction
The Operations Evaluation Department (OED) of the World Bank
comnissioned this analysis. Unlike the typical OED study, it does not analyze the
specific details of any particular Bank project or set of projects. Rather, it offers a
conceptual account of the approach to privatization and enterprise reform of three
major countries in the transition region. It discusses for each the states of mind
conceming enterprise reform and privatization that prevailed in the country and the
World Bank at various places and moments prior to and in the transition process,
the initial conditions faced by reformers and those who assisted them, and the
policy frameworks that evolved.
In each of the three chosen cases restructuring and privatization were seen
as critical by reformers, their Western academic and financial advisors, and Bank
and other international financial institution's (IFI) staff. In each case the debates on
the privatization issue raised questions of importance beyond the single country.
The intent is to complement the more traditional and detailed OED review of
projects, by illustrating the major problems and issues faced, the solutions
proposed, their evolution over time, and the policy paths rejected or missed by Bank
staff, and reformers in the transition governments, conceming the contentious topic
of privatization.
The paper is organized as follows: Section II summarizes Bank thinking on
public enterprise reform and privatization prior to the large-scale involvement in
transition. Section III briefly sketches the original moments of contact. Sections
IV, V and VI discuss the three country cases. Section VII then offers a general
discussion of what has been learned concerning what works and what does not; this
is followed by conclusions in Section VIII.
In the order they are discussed the countries are: Poland, Czechoslovakia
(now the Czech Republic and Slovakia), and Russia (at the very first, the Soviet
Union). The privatization approaches of a number of other countries will be
mentioned, though not analyzed, in passing.
II- The "mindset" of World Bank staff prior to their arrival in transition
countries, regarding state-owned enterprises and public corporations.
From the 1960s through the 1980s, the World Bank lent and credited
member governments throughout the world very large sums for the purpose of
creating and financing, and then strengthening and reforming, public enterprises.'
These activities focused mainly on infrastructure firms-electricity companies,
telecommunications, ports, railways-but there was from the outset considerable
involvement, at least through financing and attention to the policy framework and
supervisory mechanisms, in commercial, manufacturing and industrial entities as
well. The Bank had assisted member governments in this field in the hope that, in
1 Throughout this report the terms public enterprises and state-owned enterprises (SOEs) are used
interchangeably.



3
addition to providing basic and needed services in an efficient and cost-effective
manner,
... public enterprises would assist the development of "strategic" sectors,
gain access to commercial credit that would be denied to small private
businesses, fill "entrepreneurial gaps," empower numerically large but
economically weak segments of the population, maintain employment
levels, and raise the level of savings and investments.2
Towards the end of the 1970s, and certainly by the early 1980s, there was
pervasive doubt as to the attainability of these goals. Why? First and foremost,
despite concerted, intellectually innovative, expensive and repeated reform efforts
of a variety of types3, the objectives of SOE reform operations persistently were not
met. The financial and operating performance of public corporations in most client
countries remained generally poor, or actually worsened;4 the financial burden
imposed on strained governments by loss-making SOEs overwhelmed first budgets
and then banking systems, and (presumably) crowded-out desirable spending
activities of governments; infrastructure companies, even profitable ones, could not
raise sufficient investment funds, and in general firms that had been created with a
view to providing the state with surplus capital to develop the country now survived
as loss-makers mainly because of the politics of vested interests.
Second, partly as a result of disappointments and unfulfilled expectations,
many analysts and economists shifted their view of "market failure" and natural
monopoly. Changes in technology and perception introduced competition
(sometimes for rather than in the market) into formerly closed areas, particularly in
ports, railways, water, telecommunications and electricity generation and
distribution. The perception arose that the merits of non-market alternatives had
been oversold, and that both the potential of introducing competition and
contestability, and the possibilities for introducing private entry and participation
had been underestimated.
Third was the dramatic and powerful demonstration effect of restructuring
and privatization in several leading OECD countries, beginning with the United
Kingdom at the end of the 1970s, and followed thereafter by Canada, New Zealand,
France and others. If privatization could successfully be applied in these settings,
why not in developing countries where the need and scope for improved efficiency
was so much greater?
By the mid-1980s, the dominant view among Bank staff working on SOE
reform was that the available set of improvement mechanisms, short of ownership
2John Nellis & Mary Shirley, Public Enterprise Reform: The Lessons of Experience, World Bank,
EDI Development Studies, Washington, DC, 1991, p. 1.
3 The range of reforms short of ownership change were summarized by Mary Shirley in Managing
State-Owned Enterprises, World Bank Staff Working Paper No. 577, Washington, DC, 1983; and in
Nellis and Shirley, Public Enterprise Reform, op. cit. For a listing and analysis of public enterprise
reforms attempted by the Bank in adjustment, lending in the 1980s see John Nellis, "Public
Enterprise Reform in Adjustment Lending," Working Paper WPS 233, World Bank, August, 1989.
4See for example, the information on poor performance, despite repeated reform efforts,
summarized in John Nellis, Public Enterprises in Sub-Saharan Africa, World Bank Discussion
Paper No. 1, Washington DC, 1986.



4
change, was hard to apply and even more difficult to sustain,5 and that more hope
was offered by privatization-which had begun to occur in some non-OECD
settings, primarily in Latin America.6 The premises for operational action were:
>   SOEs did not function well; more importantly, it was next to impossible to
make them function well.7
>   However, up to the middle 1980s there was no widespread or solid
foundation of empirical evidence proving the operational superiority of
private versus public firms8; and a number of academic studies contrasting
public and private ownership had concluded that market structure and the
The argument is developed in John Nellis, Is Privatization Necessary? Viewpoint, FPD Note No. 7,
World Bank, May 1994:
... most governments find it difficult if not impossible to apply the entire package of
qualifying conditions that are essential for reforms short of ownership change to work. The
landscape, particularly in developing countries, and now in ex-socialist countries as well, is
littered with partial attempts to impose reform where the government owners hadn't the will
or the capacity or the luck to impose the whole of the reform package-and the results were
minimal, modest or nonexistent ...... Second, in the few cases where governments do
establish and maintain the precedence of commercial aims, the results are ..... very good.
But they tend not to last. In most instances there is pronounced backsliding. The common
story is that bad times make for good policies-in crises govermnents do establish the
precedence of commercial objectives, they do impose a harder budget constraint, and they
do give autonomy to public enterprise managers to achieve commercial aims. But again
and again, when the crisis fades, or when the regime changes, or when some major political
claim arises, commitment to the priority of commercial aims and to non-interference in day-
to-day management of the firm fades with it ..... Ultimately ...... politics trumps
economics." (p. 4)
6 Recall that by the end of 1988, largely without prodding by donors, Mexico had reduced its very
large SOE sector (1155 firms in 1982; accounting for 14% of GDP) by more than two-thirds, by
selling 150, liquidating 260, and transferring or putting into mergers an additional 400 entities. And
all this was before the major infrastructure firms were sold in the main wave of privatization in the
1990s.
7 Almost but not quite impossible. In 1984 New Zealand "corporatized" a number of its SOEs, by
reducing political controls in these firms; enshrining managerial and board autonomy and rewarding
them accordingly; establishing commercial profitability as the over-riding goal, and using changes in
net worth as the measure of success; requiring parliamentary passage of any subsidy or deviation
from commercial operation, and a number of other radical departures from typical SOE governance.
Performance generally improved. However, most developing country representatives sent to
observe the process (usually by the World Bank) came away daunted by the revolutionary scope and
pace of the needed reforms rather than impressed by the operating results, and daunted by the fact
that despite the gains from reform, the New Zealanders had eventually proceeded to privatize most
of the corporatized firms.
8 Later empirical research has persuasively demonstrated that privatization is generally and strongly
associated with improved financial and operating performance at the level of the firm. For a full
review of the issue see William Megginson and Jeffrey Netter, "From State to Market: A Survey of
Empirical Studies on Privatization," Journal of Economic Literature, Vol. XXXIX (June 2001), pp.
321-389.



5
degree of competition were more important than ownership in determining
performance and efficiency outcomes.9
>  In addition, while first assessments were very promising, arguments were
nonetheless common that it was too soon to tell whether privatization was
working in Europe, and a debate started (and still continues) as to whether
perceived performance improvements are due more to enhanced competition
and liberalization rather than ownership change.
>  Moreover, even if ownership change did account for a good part of the
positive results seen in OECD settings, and perhaps in middle-income
economies such as Mexico, many-even within the World Bank-argued
that one could not anticipate similar results in lower-income developing
countries, with their thinner capital markets and weaker institutional
settings.
>  Almost all acknowledged that privatization was intrinsically complicated
and intensely political in nature; meaning
>  Sales tended to take a great deal of time to structure (because of deficient
records and accounts, the size of both normal and contingent liabilities, and
the need for financial engineering prior to sale), to "sell" to the various and
usually opposed stakeholders, and to win final approval from authorities.
Moreover,
> The larger the firm the more time needed to complete the transaction.'0
All this instilled within Bank staff a general preference for privatization,
tempered by a recognition that it was a contentious, difficult and slow process; and
that definitive evidence was not yet in as to its utility, or the possibility of its
application in non-OECD settings. Still, ever-increasing losses, seemingly
insurmountable-under public ownership-investment constraints, and mounting
evidence of other and serious performance flaws in SOEs, led Bank staff
increasingly to consider the privatization option.
By the end of the 1980s public enterprise reform had become a key
objective of Bank assistance. A 1989 review calculated that SOE reform had, to
that date, featured prominently in 101 adjustment operatiorns in 34 different
countries, 18 of these in sub-Saharan Africa. (Through 1989, Bank-supported
adjustment operations containing SOE reform had taken place in only one country
that would enter transition, Yugoslavia.) Twenty-one of the 101 operations
imposed as conditionality the full or partial sale, lease or liquidation of an SOE or
9 For example, Robert Millward reviewed the (scant) information available in the 1980s and
concluded: "There is no evidence of a statistically satisfactory kind to suggest that public enterprises
in LDCs have a lower level of technical efficiency than private firms operating at the same scale of
operation." Found in his "Measured Sources of Inefficiency in the Performance of Public and
Private Enterprises in LDCs," in Paul Cook and Colin Kirkpatrick, eds., Privatisation in Less
Developed Countries (New York: St. Martin's Press, 1988, p. 157).
'0 This was the principal and oft-repeated conclusion of many of the early students of the process, for
example Roger Leeds: "There is an unfailing tendency to underestimate the time required to execute
each privatization transaction ......... In his "Privatization in Developing Countries: Some Lessons
Learned," unpublished paper delivered to the International Privatization Conference, Saskatoon,
Canada, 1990, p. 9.



6
set of firms, and a large number of other reforms/conditions were clearly viewed as
preparation for sale or closure."1 Indeed, conditions concerning privatization or
preparation for divestiture were more numerous than any other single reform
category.
Nonetheless, taken cumulatively, measures other than ownership
change including performance contracts between managers and government
owners, financial and management audits and restructuring, rehabilitation and
restructuring schemes under continued public ownership, and review and guidance
mechanisms by which government would improve supervision of its SOEs-far
outnumbered privatization measures: The study tabulated 29 ownership change
conditions versus 104 non-ownership change conditions. This continuing emphasis
on reform under state ownership, alongside privatization, would prove to be an
important and revealing difference from the SOE reforms later proposed and
supported by the Bank in transition countries. Operations to reform SOEs in
transition economies were limited to "isolation" exercises in a number of countries;
that is, efforts to impose something akin to a Chapter 11 workout on a set of large
loss-makers as preparation for either their full or partial sale, or closure. An overall
assessment of this specialized aspect of enterprise reform remains to be done (and is
not attempted here); a rigorous study of the Bank-supported Romanian "isolation
program concluded it had been a failure.'2
III-    What were the conditions at the outset?
Prior to transition, the World Bank had made loans to several centrally
planned or socialist European governments: Romania, Hungary, Poland and
Yugoslavia. While at least some staff had a general awareness of the situation they
would find in these countries, it could not be said in 1990 that the Bank possessed a
great deal of specialist knowledge on the workings of centrally planned economies.
Nor were many such specialists employed to take part in first missions to these
countries. Recall, however, that the political and economic change that swept over
the centrally-planned and socialist economies at the very end of the 1980s was
enormous in scope and lightning-like in speed; it was vast, swift and largely
unanticipated-at least by outsiders.'3
The numbers and the type of reform requested or required are found in Nellis, "Public Enterprise
Reform and Adjustment Lending," op. cit., see especially Table 3, p. 15.
12 Simeon Djankov, "Enterprise Isolation Programs in Transition Economies," Policy Research
Working Papers No. 1952, Washington, D.C.: World Bank, 1998.
13 At the first meeting in Moscow, in September 1990, with the first review team from the IFIs
(World Bank, IMF, EBRD and OECD), the "All Union" Soviet Minister of Justice began by stating:
"I hope that when the present debate ends the constituent parts of the present Soviet Union will
retain a degree of economic relations equal to that of the European Community." The statement
astonished the team; few of us were fully aware of the extent of decay of the Soviet state and
economic system; and indeed the final report of the IFI team was still entitled The Economy of the
USSR, although the report itself noted that "by December of 1990, all 15 union republics had
declared either independence or sovereignty." (p. 11). We non-specialist outsiders were among the
last to know; it was later brought to our attention that one of the reasons Andrei Sakharov had been
internally exiled as far back as 1980 was his assertion that the Soviet Union would eventually
collapse due to irrational economics and unmanageable ethnic tensions. The points are (i) as so



7
At the same time, the group of centrally planned economies was not viewed
as monolithic. Poland's internal struggle between the labor movement, Solidarity,
and the regime, and its increasing democratization had been closely followed; and
the establishment of the first non-communist government in Poland in September
1989 was clearly a defining moment in the transition to transition. Moreover,
Hungary's long-standing set of cautious but cumulatively significant liberalization
steps had been recognized and analyzed, and Yugoslavia's distinctive socialist path,
and wide and deep economic relations with Western markets, were acknowledged
facts. Nonetheless, even careful students of the region were caught unawares; the
speed with which the seemingly solid system collapsed-the fall of the Berlin Wall,
the Velvet Revolution in Czechoslovakia, the overthrow of Ceaucescu in Romania,
the demise of the Soviet Union, the collapse of Yugoslavia-all were more
unexpected than not.
Poland, because of its early starting point, the manner in which most of the
key enterprise reform issues-speed of privatization, choice of method, use of
vouchers and a "mass" approach, and the respective weights and roles of ownership
and institutional/policy change-is clearly the place to begin.
IV- Poland
In Poland at the beginning of 1990 one found a radical reformist regime,
willing and able in this period of "extraordinary politics"''4 to undertake sweeping
reform, and convinced that privatization of the massive state enterprise sector was
an essential next step. As in a few other centrally-planned economies, most notably
Hungary and to a lesser extent the Soviet Union, enterprise reform efforts of the
1980s (and even earlier) had tried to overcome falling rates of return on investment
by lightening the amount of control of planners and decentralizing decision-making
to the level of the firm. One result, here and in every country that tried this
approach, was the increase of enterprise autonomy and the margin of maneuver of
firm managers. This had resulted in only modest benefits in terms of increased
production and cost cutting, while the disadvantages of increased managerial
autonomy would subsequently, in most settings, prove to be very high.
Another feature of pre-transition Polish enterprise reform was that workers'
councils had been created and empowered to negotiate with management and
branch ministries on the entire range of production issues.       Russia and
Czechoslovakia too had created such councils, but at the last minute, in the latter
half of the 1980s. In Poland, this was a much more serious and long-standing
effort, partly in response to the decentralization ethos, but also clearly in an effort to
placate Solidarity (Hungary's experience with workers councils was somewhere in
often, what seems in retrospect to be obvious and inevitable was not so evident at the time; and (ii) it
is not in the nature of the IFIs to be ahead of the political curve.
14 The term comes from Leszek Balcerowicz, Minister of Finance and Deputy Prime Minister in the
first non-communist government in Poland, established in September 1989; and applier, if not
inventor, of the "Big Bang" approach to transition. The idea was that the euphoria created by the
escape from the communist system (and Russian domination) resulted, for a time, in a suppression of
normal political competition and gave, again for a time, remarkable policy latitude to the
replacement regime.



8
between).   The overall point is that by the time World Bank teams arrived in
Poland, the responsibility for SOEs had been substantially decentralized from a
discredited central government and weakened sector ("branch") ministries;
decision-making powers at the level of the firm were split basically between
managers and workers.
The second and obvious factor of import was the sheer number of medium
and large sized firms to be dealt with: the official starting count in Poland-was
8,400 SOEs, 1 accounting for between 70 and 80 percent of GDP-and this did not
take into account a number of subsidiaries of the larger firms, nor a good number of
economic entities controlled by sub-national governments. Most Polish authorities
met announced their complete support for rapid privatization of this mass of firms;
the official goal was, as soon as possible, to "develop an ownership structure akin to
that of industrially developed nations."16
Privatization of small units was, indeed, implemented very rapidly. By the
end of 1992, small privatization in Poland was almost complete, with the
privatization of 194,000 units, i.e., 82 percent of the units existing in 1989. Most
such units were in retail trade and services; they were allocated to former
employees at well below market value. Small-scale privatization in Poland (and
indeed almost everywhere else in transition) was relatively non-contentious, and has
been judged to have been a great success, in terms of improving the quality and
quantity of the services and goods provided, in creating a large number of jobs for
those shifting out of the restructured SOEs and privatized firms, and in generally
smoothing the path for the return of capitalism. The importance of small-scale
privatization in the region is very great, yet the topic has never received the
analytical attention it deserves.17
The basic problem.....
The fundamental privatization problem quickly became apparent; the issue
was the medium and large- sized firms. Methods and experience derived from the
OECD and middle-income privatizing countries clearly showed how slowly the
process normally unfolded. In the United Kingdom, Mrs. Thatcher's enthusiastic
and dedicated privatization team had managed to divest about 20 companies in a
ten-year period. The Mexicans, starting with a larger number of (much smaller)
firms, had sold off about 150 entities in six years. Assuming that the Poles could
somehow double or treble the average annual sales numbers of these leading
privatizers, it was estimated they might be able to sell, say, 30 large firms a year,
relying on the sales methods that had been used elsewhere.
15 Due to sectoral and size classification problems, there was some confusion as to the number of
SOEs to be dealt with. For example, Jeffrey Sachs and David Lipton stated that as of 1988 Poland
possessed a precise 3,177 "state enterprises in the industrial sector..." "Privatization in Eastern
Europe: The Case of Poland," in Andreja Bohm and Vladimir Kreacic, Privatization in Eastern
Europe: Current Implementation Issues (Ljubljana: International Center for Public Enterprises in
Developing Countries, 1991), p. 29.
16 Personal mission notes, January 1990.
17 Save for an early and excellent study by John Earle, Roman Frydman, Andrej Rapaczynski and
Joel Turkewitz, Small Privatization: Transformation of Retail Trade and Service Sectors in
Poland, Hungary and the Czech Republic (New York: Central European University Press, 1994).



9
The math was daunting: 8,400-or even 3,177-divided by 30, or by 60 or
100, yielded what seemed like ludicrously long periods of time before privatization
would be substantially underway, much less complete. In the early days in Poland,
and as we shall see, even more so in Czechoslovakia and Russia, most reformers
and many external analysts and observers were aghast at the prospect of
privatization unfolding slowly over a decade.
Just why was it thought that extensive delays in privatization would be a
serious, indeed dangerous problem? The primary reason was one of political
economy: the fear that delaying change of ownership would provide opportunities
for the return of the communists. The very speed and relative ease of the victory
over the communists had its worrisome aspects. It raised concems that the victory
might just as readily be reversed; that the communists, with or without external
assistance, might somehow regain power and attempt to set back the economic
clock.18 The idea gained credence that one way to increase quickly support for the
reintroduction of capitalism was to create more capitalists; that is, through
privatization, to build up rapidly and dramatically the number of private owners of
productive entities. This, it was thought, would create a group of people with a
stake in and commitment to the market reforms so vigorously pursued by the new,
non-communist Mazowiecki government.
A second justification for speedy privatization was the fear that leaving the
firms in the control of largely unaccountable managers would open the door to more
"wheeling, dealing and stealing." It was apparent from the beginning that the
breakdown of the old order and the increase in control rights of firms managers was
leading, in Poland and elsewhere, to "spontaneous privatization," whereby
managers obtained full or partial ownership of the firms they had worked in, at low
or no cost, and in a non-transparent manner. The assumption at the outset was that
delays in privatization would exacerbate unfair transfer and asset stripping in the
unsupervised firms, and that when formal privatization did occur, there would be
little remaining of value. Ironically, given privatization's present reputation in
many transition countries as a prime cause of increased corruption, it was originally
viewed as the best available measure to increase transparency and probity.
The belief in the necessity of mass and, in particular, rapid ownership
change was widely but not universally held. The most eminent of those with
reservations was Janos Kornai. Writing in 1990, he offered the contrary and
prescient view that the state, even the post-communist state, "... is obliged to handle
the wealth it was entrusted with.. .until a new owner appears who can guarantee a
safer and more efficient guardianship. The point now is not to hand out the
18 For Poles this was not an abstract possibility. Recall that as recently as December of 1981 the
Polish army, with the approval of Soviet authorities, had declared martial law, suspended civilian
rule, interned 10,000 members of Solidarity, sent tanks into the Gdansk shipyards, shot dozens of
demonstrators, and tried to resurrect "traditional" socialist production methods. Recall as well that
in late 1989 and for some time to come there were still substantial numbers of Soviet troops
stationed in East Germany, Poland, Hungary, Czechoslovakia and, of course, Lithuania, Latvia and
Estonia. Recall further the August 1991 attempt by hard liners to reinstate more traditional rule in
Russia. The threat seemed real enough.



10
property, but rather to place it in the hands of a really better owner."19 A decade
along not many would contest the wisdom of Professor Kornai's point. But at the
time the assessment of most-in which group I numbered-was that his
prescription was perhaps applicable to Hungary, which had since 1968 (with the
launching of its "New Economic Mechanism") been experimenting with piecemeal
introduction of market mechanisms into a modified central planning structure. But
what might work in evolutionary Hungary was unlikely to work in more closed, less
liberalized countries, especially those that had not wrested a margin of maneuver
from their internal hard-liners. Thus, most reformers and observers, while
acknowledging their respect for Kornai, retained their conviction in the need for
speed.
Differences in views...
However, it soon became clear that there were deeply conflicting views
among Polish reformers on how to proceed with privatization. The period of
extraordinary harmony among the various partners in the anti-communist coalition
was real, but it proved easier to gain consensus on seemingly abstract pricing and
trade policy reform than on the more tangible question of precisely how to privatize
a state-owned firm.
The conflict played out in the formulation of the law on privatization, which
went through some twenty or more drafts and endless and heated debate in the first
semester of 1990, before finally receiving passage in July. The saliency of
Solidarity within the coalition was the cause. As with unions worldwide, Solidarity
leaders were suspicious of privatization and wanted workers to have some
substantial say in how, and to whom, an SOE would be sold. They first suggested
a process whereby each workers council would have to be consulted before a firm
could be put on the market. If the council rejected the privatization option the firm
would simply remain in state hands. Bank staff, strongly supported by a vocal and
visible cadre of external analysts and advisors (most notably, Jeffrey Sachs and
David Lipton), argued against this position. The fear was that this was a recipe for
inaction and continued losses and inefficiencies in the mass of firms.
Bank staff and others cited evidence from socialist and non-socialist
countries showing that workers, when given ownership or management powers,
tended to use them to protect their jobs and increase their wages rather than
restructure firms to enhance their competitiveness.20  Bank staff, along with the
19 Janos Komai, The Road to a Free Economy: Shifting From a Socialist System--the Example of
Hungary (New York: Norton, 1990), p. 82. Komai has recently revisited the subject; see the
section on "Ownership reform and the development of the private sector," in "Ten Years After 'The
road to a Free Economy:' The Author's Self-Evaluation," paper delivered to the Annual Bank
Conference on Development Economics, Washington, D.C. April 2000, pp. 6-20, in which he
makes a good case that his diagnosis and prescription was superior to the altematives pursued. Peter
Murrell of the University of Maryland was another early skeptic regarding the need for and utility of
massive and rapid ownership changes; see his "Evolution in Economics and in the Economic Reform
of the Centrally Planned Economies," in Christopher C. Clague and Gordon Rausser, editors, The
Emergence of Market Economies in Eastern Europe (Cambridge, Mass.: Blackwell, 1992), pp. 35-
53; and "Conservative Political Philosophy and the Strategy of Economic Transition," East
European Politics and Societies, Vol. 61, No. I (Winter, 1992), pp. 3-16.
20 This view was strongly presented in a widely read, very influential Bank paper of the time. See
Manuel Hinds, "Issues in the Introduction of Market Forces in Eastern European Socialist



external advisors and many in the Polish government, thought that restructuring of
Polish state firms was desperately needed, to cut costs and improve quality-or
shift product lines entirely-to allow these firms to compete in non-socialist
markets. Recall that the extent of the trade shock due to the collapse of
COMECON was becoming apparent. By mid-1990 Poland had lost huge amounts
of it pre-transition export markets. Production in Polish state firms had declined 30
percent from the year before, and official unemployment had risen from 10,000 in
early 1989 to 640,000 just a little over a year later. The perception was that this
growing crisis could not be contained unless the mass of productive assets,
presently being used sub-optimally in state firms, was shifted quickly to better use.
The consensus view among Bank staff and external observers was that acceding to
the claims of the workers would compound Poland's economic difficulties by
delaying or halting restructuring.21
In sum, based on non-transition experience and a first reading of evidence
on the ground, Bank staff generally thought that Polish privatization would take
time to unfold, and that the claims being made on behalf of the workers would
further delay and dilute divestiture. Believing that these delays might prove fatal to
reform, staff suggested that the Polish government reassert centralized, government
control over the firms so that (i) they could more readily be privatized, and (ii) be
more effectively and efficiently managed in the interim.
Polish authorities rejected this suggestion, arguing, "If the state was capable
of managing firms effectively, then central planning would have worked." Their
".... main rationale for this position was that the workers had better motivation than
bureaucrats in ensuring efficient work by their managers."22
Bank staff were taken aback by the vehemence of the rejection, and the faith
in the workers' councils. At the outset they did not comprehend the depth of the
mistrust of state apparatuses that communism had left in the minds of reformers, or
the extent of the debt the reformers owed to Solidarity. Reformers' deep-seated
suspicion of bureaucrats translated into rejection of any tactic of withdrawing one
step-by reasserting state control and disempowering workers' councils- in order
to jump ahead two steps. Bank staff may have still been thinking in terms of SOE
reform and privatization in mixed economies, where it was generally (if incorrectly)
Economies," World Bank Europe-Middle East-North Africa Region Discussion Paper IDP-0057,
April 1990.
21 Thus Sachs and Lipton argued in mid-1990:
"Workers' desires to block privatization may also increase rapidly in the near future if, as expected,
unemployment rates rise sharply in Eastem Europe. Workers may assume, with some justification,
that their job tenure will be undercut by the privatization of their firms. Even if workers in a
particular enterprise do not actually block privatization, they may attempt to bargain with the
govemment, demanding for example a cut in the enterprises' debts or various guarantees on
employment levels, as their "price" for letting the privatization go forward. If the govemment
becomes enmeshed in case-by-case bargaining, there will be no end in sight, given that hundreds of
large enterprises must be privatized." They feared the outcome would be "paralysis."
("Privatization in Eastem Europe: The Case of Poland," op. cit., p. 28)
22 See the excellent study by Marek Dabrowski, Stanislaw Gomulka and Jacek Rostowski, "Whence
Reform? A Critique of the Stiglitz Perspective," Warsaw: Center for Social and Economic
Research, 5th draft, March 2000, p. 21, footnote 23. All three of these reforming Polish economists
were personally involved in the early discussions on privatization with the World Bank.



12
supposed that a new regime could more or less impose its will on to the
bureaucracy. Those who came to power immediately after the communists had no
such illusions; this was a principal reason for the failure of staff to persuade
reformers to introduce measures to more effectively manage assets in the run-up
period to privatization. The reformers realized how thin was the veneer of change
so far imposed on to the largely unreformed (and in their eyes, unreformable)
inherited administrative machinery.
The Polish privatization law passed in July of 1990 thus stipulated that
enterprises would only be sold with the approval of insiders, meaning the managers
and workers councils. Insiders were encouraged to voluntarily submit their firms
for sale to the newly created Ministry for Ownership Change. As a compromise,
the law allowed the Ministry the possibility of designating a firm for sale without
the approval of insiders, and the insiders could appeal a ministerial designation to a
parliamentary committee, whose decision would be final. But this feature was
rarely if ever applied. Ministry officials acknowledged in private that only firms
voluntarily entering the process would be privatized. The hope was that insiders in
a group of high potential firms-most likely consisting of those already exporting
to hard-currency markets, in fairly good financial shape, and not likely to require
major layoffs-would be persuaded by self-interest to submit themselves for
privatization, thus gaining skilled management, capital, market access and technical
know-how for their companies. The authorities hoped that 80 to 150 firms would
enter the process in the first year. "Trade sales"-negotiated case-by-case
transactions- and sales through share offerings on the rejuvenated Warsaw Stock
Exchange were the anticipated methods.
Article 37 of the law also allowed for what was termed "privatization
through liquidation." Mainly applied to smaller SOEs, this article permitted firms,
without passing through a court insolvency procedure, to sell assets (usually but not
exclusively to insiders, and usually by means of installment payments), lease out
assets (also to insiders), enter into joint ventures, and merge with other firms.
Thirty-three transactions were concluded by these means in 1990, but the number
jumped to 397 in 1991 and continued high thereafter. This became a principal,
invaluable method for providing small and SME start-up businesses with the assets
and real estate they desperately required.
Funds and vouchers.....
Some reformers and Bank staff recognized at once that the procedures
sanctioned by the law would move slowly, and that the interim asset management
problem had not at all been solved. They thus began to cast about for additional
measures to speed and deepen the process. In March of 1990 the Ministry of
Finance proposed that between ten to twenty "state holding companies" be formed,
"guided by purely commercial criteria," fully managed by reputable and
experienced (and thus most likely foreign) private businesspeople, with the
objectives of first shifting firms in their portfolios to market-oriented operations,
and then privatizing them.23 The idea was at first solely one of asset management
leading to privatization. Over the next year it became combined with a second
23 Ministry of Finance, Warsaw, "Holding Companies as a Means of Accelerating Privatization in
Poland," March 7, 1990, p. 1.



13
notion, that of distributing widely a portion of the ownership in the holdings-and
thus indirectly in the firms in the holdings' portfolios-to the populace by means of
share give-aways, or vouchers.24
As vouchers became the chief and widely applied innovation in privatization
in transition countries it should be noted that they were a Polish invention at the
very beginning of the transition period.25     The Polish government's original
intention in using vouchers was not necessarily to speed privatization; rather it was
designed, stated a high privatization official in November of 1990, to deal with
"...the disparit, between household savings and the net asset value of state
enterprises...."2 That is, vouchers were viewed as a means of providing citizens
with the power to purchase shares and assets in state firms that, if sold strictly for
cash, would go only to wealthy locals (who were assumed to have amassed their
cash in dubious ways) or to foreigners.
The marriage of the holding company idea with a give-away scheme took
root in 1991, as evidence mounted as to the very meager results of privatization
through either trade sales or share offerings. There were no or extremely few IPOS
concluded in 1990, as opposed to the dozens that had been predicted by authorities
(the Warsaw stock exchange did not officially re-open until April of 1991, trading
the shares of precisely five privatized firms); and the number of trade sale
transactions was also very small and far less than anticipated. This slow pace of
sales of large firms continued to be the case for years to come. The authorities, with
the approval and assistance of the Bank, responded in 1991-92 in two ways: first,
by dividing the SOEs into nine sectors,27 and seeking advisory assistance on how to
deal with the set of firms on a sectoral basis; and second by what was called a
24 On reading the MoF note, in May of 1990 I wrote and distributed in the Bank a memo saying this
was a generally good idea, and added: "But why not go one crucial step further; why not think about
the free distribution.. .of say 20 percent of the shares in each holding company, to a portion of the
general public? The idea here is to assign... .to a group of citizens a minority of shares in each
holding created.. .In this way self-interested citizens, and not just disinterested bureaucrats, would at
least begin to have a direct personal stake in the holding's performance....A share give away to all
citizens would mute the need to award concessions to workers in the privatized firms." That this
approach would probably cause large "technical, administrative and political problems" was
acknowledged "...but I think the potential benefits of widespread private ownership, even in this
partial, preliminary and indirect fashion, outweigh the evident costs." World Bank Office
Memorandum of May 3, 1990, "Poland: Proposal to Form State Holding Companies for Public
Enterprises," p. 1. Others in Poland and among the advisory community were thinking along the
same lines and advocating similar schemes.
25 The idea was first put forward by Janusz Lewandowski and Jan Szomburg, in their "Property
Reform as a Basis for Social and Economic Reform," Communist Economies, Vol. 3, January 1989,
pp. 257-268. Lewandowski later became Minister for Privatization. For the record, it should be
noted that the first recorded free transfer of equity in government-owned firms to the public was in
the Canadian province of British Columbia at the end of the 1970s; see Guy Heywood, "Giving it
Away: Case Study of the British Columbia Resources Investment Corporation," unpublished paper
presented to a World Bank Conference on Privatization in Less Developed Countries, Washington,
DC, June 12,1990.
26 Gregory T. Jedrzejczak, "Privatization in Poland," in Bohm and Kreacic, op. cit., p. 85.
27 Construction, pulp and paper, glass, cement/limestone, rubber and tires, cables and wires,
furniture, breweries and confectionery goods. In 1991-92 the IFC was involved in one or more
sectors.



14
"Mass Privatization Program," or MPP; a combination of the asset management
concept with a give away scheme.
The basic idea of the MPP was as follows: Between 400 and 600 (eventually
512 firms entered the MPP) medium- to large-sized SOEs would be selected,
converted to joint stock companies, and allocated in an equitable manper to 15
"National Investment Funds" (NIFs)-all of which would be managed by
"international firms that have demonstrated experience in managing investment
funds and giving strategic guidance to companies..."28 Firms being privatized by
some other route, in severe financial difficulty, or monopolies requiring post-
privatization regulation were excluded. Sixty percent of the shareholding in each
selected firm would be held by the NIFs; 33 percent by a lead NIF (for this firm),
and 27 percent distributed equally among all other NIEFs. Ten percent of shares
were to be distributed free of charge to employees in the affected firm. The
remaining 30 percent would continue to be held by the State Treasury. NIF
managers would receive a fee for their services, plus a portion of the sale price upon
subsequent privatization, thus giving them an incentive both to privatize and to
maximize the value of their holdings. Finally, for a small fee, any and every adult
citizen of Poland could obtain a "bearer MPP share certificate," giving the holder a
share in each NEF.
Though conceived in 1991, the law establishing the MPP was not passed
until April of 1993. Moreover, due to bitter and divisive arguments over the powers
and selection of the foreign managers, exactly which firms should and should not
enter the program, and fears of workers that entry into the MPP would mean loss of
jobs, the system was not started until the end of 1995-and did not list the shares of
the funds in their portfolios and enter an active phase until the first half of 1997.29
This illustrates the intense and continuing difficulty of forging a consensus in
Poland on privatization procedures for the large-scale firms.
Outcomes....
The upshot was that by the end of 1996-at which time a number of other
transition states, that had begun privatizing some time after the Poles, had worked
well through the process-there remained in Polish state hands a surprisingly large
number of firms, and a surprisingly large percentage of assets and initial value (see
Table 1).
28 Jerzy Thieme, Jacek Bukowski, Michai Mrozek and Teresa Pinski, "Privatization in Poland-
1992," in Andreja Bohm and Marko Simoneti, editors, Privatization in Central and Eastern Europe
1992 (Ljubljana: Central and Eastern European Privatization Network, 1993), p. 192.
29 Barbara Blaszczyk and Richard Woodward, editors, Privatization and Company Restructuring in
Poland, edited by Warsaw, Center for Social and Economic Research, Case Report No. 18, 1999, p.
11.



15
Table 1
Numbers & Methods of Polish SOEs Privatized as of December 1996
State Firms as of 31/12/90            8 441        Comments
Transformed to companies wholly       1,227        183 privatized;
owned by State Treasury                            512 to NIFs
Of these, some designated as of       160          Held out of
"special importance"                               privatization
Liquidated under 1990 Privatization   1,247        as of end 1996, 26
Law (asset sales)                                  cases still pending
Liquidated under State Enterprise law  1,464       Only 494 of these
completed; by end
1996, 441 in
bankruptcy
Insolvent or liquidated under Bankruptcy  662      304 of these still in
Law                                                process
Taken over by Agency for Agricultural  1,654       Some sold, some
Property                                           some subject to
management contracts;
figures vague
Turned over to local governments       263         Subsequent status not
given
Total number of enterprises "subject to  5,592
"ownership transformations"
Of which, privatization completed     1,89830
Thus, official figures suggest that only 22 percent of the starting stock of 8,400
SOEs was privatized after six years of transition. Even taking the smaller number
"subject to ownership transformations," the privatization percentage is just one-
third. Clearly, despite official statements and hopes, and despite considerable
30 Source: Blaszczyk and Woodward, ibid., p. 11, citing the Central Statistical Office, 1997, and
other official sources.



16
prodding and assistance from the World Bank,3' Poland turned out to be a very slow
privatizer.
The question is, does it matter? The fact is that Poland has enjoyed just
about the overall best growth record of all European and Central Asian transition
countries. It returned to growth more rapidly and with more vigor than most other
transition economies, and for a time in the mid-1990s had the highest GDP growth
rate in Europe. By late 1999 its GDP was estimated at 125 percent that of GDP at
the end of 1989, an excellent record of positive economic achievement. Did the
Poles manage this accomplishment despite the slow pace of privatization, or
because of it?
In retrospect one can discern a "Polish model of transition" that succeeded
without mass or rapid privatization. This consisted of complete liberalization of
entry (January 1989); abolition of communist organizations in SOEs and formal
endorsement of the power of workers' councils (end/1989); liberalization of about
90 percent of prices (throughout 1989); stabilization through tight fiscal, monetary
and wage policies, including hard budgets for SOEs (January 1990); and near
complete trade liberalization and current account convertibility (January 1990).32
Note, however, that all involved, from Balcerowicz on down, readily admit that this
winning policy package was initially regarded as incomplete. Many reformers, and
most in the advisory community, felt at the time that the lack of rapid, mass
privatization-consistently blocked by union power and a lack of political
consensus among the many and vigorously competing non-Solidarity parties,
evidenced in the frequent change of governments and ministers-was a serious,
probably crippling omission.
Regarding privatization, one can see in hindsight that in the Polish context
the introduction of free trade and free entry for new start-up businesses, combined
with a tightened budget constraint on most remaining SOEs, and the introduction of
the mechanism for spinning-off productive assets from SOEs without formally
privatizing them, presented a viable alternative to mass and rapid divestiture. First,
in conjunction with quick and extensive small-scale privatization, these policies
encouraged the explosive growth of de novo private firms, which turn out to be the
principal engine of recovery and growth in transition econo'rnies. In'terms of
restructuring they consistently outperform privatized firms, much less SOEs.33
Second, one also has to admit that the workers' councils, so worrisome to both
Bank staff and external advisors in 1990, ultimately proved to be a positive force in
Polish SOEs.    In other transition economies-Bulgaria and Ukraine, for
example    where the old centralized state structures and sectoral ministries
crumbled, where firm managers took over the control of assets, and where
Early real sector reform operations of the World Bank in Poland included a Structural Adjustment
Loan approved in July 1990, a Privatization and Restructuring Loan (with minimal and rather
general conditions and lots of technical assistance) and a Financial Institutions Development Loan,
both approved in July 1991, and an Enterprise and Financial Sector Adjustment Loan approved in
May 1993.
32 Dabrowski et al.,op. cit., p. 12.
33 A finding confirmed by many, including Oleh Havrylyshyn and Donal McGettigan, "Privatisation
in Transition Countries," Post-Soviet Affairs, Vol. 16, (July-September 2000), pp. 257-286.



17
privatization was accepted in principle but not extensively carried out in practice,
but where workers' councils were weak or non-existent, the result was asset-
stripping and deterioration of firm quality on a large scale. Poland avoided this
outcome by good macro-economic and financial policies, but also because in the
firms the workers' councils were keeping an eye on managers, and checking if not
totally preventing them from asset-stripping and "spontaneous" privatization. The
combination of good policy, vigorously applied, in-firm watchdogs, and small-scale
privatization limited both output fall and criminal behavior in Polish SOES.3
One might thus argue that the Poles, even if by default more than intent, (i)
did well not to privatize their medium and large firms rapidly; and that (ii) many
other transition countries would have been better off had they followed the Polish
approach and privatized larger firms more slowly.
My view is that the first conclusion is quite conceivable but not
proven-and perhaps not provable. The problem is the counterfactual: The same
good policy set that minimized production falls in the SOEs might have spurred
privatized firms to even better efficiency and effectiveness levels. Some evidence
for this was provided (later) by Blaszczyk and Woodward, whose 1999 study on
restructuring in Polish firms showed that "ownership status is the most important
factor differentiating the sample... .the best financial standing or the fastest growth
rate was recorded by privatized enterprises." They agree that "indicators for state
treasury companies and firms from the Polish privatization group were similar
through 1995..." But then the performance of privatized firms ".....stabilized, while
state-owned firms have been hit by a dramatic decline caused by the capital
shortage barrier."35 Ownership matters, at least eventually.
Overall, it is undeniable that Poland did well, but the feasibility and the
benefits of the privatization path they followed were not at all clear at the outset.
And, given the sound policies quickly established and enforced in Poland, they
might even have been better off with more and earlier large-scale privatization.
The second assertion, that other transition countries might have done well to
adopt the Polish approach, is even more problematic. The problem here is that one
cannot borrow a single part of an integrated policy package applied elsewhere and
expect it to replicate the full range of effects achieved in the original instance. In
other words, it is illegitimate to concentrate on the pace and scope of privatization
in Poland without taking into account the surrounding policy and institutional
environment. Evolutionary and cautious large-scale privatization worked in Poland
because it was enmeshed in a setting of sound and well-applied economic and
34 Some, including some at the World Bank, saw this earlier than others. See B.Pinto, M. Belka and
S. Krajewski, "Transforming State Enterprises in Poland: Microeconomic Evidence on Adjustment,"
World Bank Policy Research Working Paper, WPS 1101, 1993, which showed no or insignificant
differences in performance between the SOEs and privatized firms in their sample. See also B. Pinto
and S. van Wijnbergen, "Ownership and Corporate Control in Poland: Why State Firms Defied the
Odds," World Bank Policy Research Working Paper 1308, June 1994, which details the policy and
financial measures that contributed to good SOE performance, and explains why privatization was,
nonetheless, still necessary. In light of the findings later reported by Blaszczyk and Woodward, this
conclusion holds up pretty well.
35 Blaszczyk and Woodward, op. cit. pp. 45-6. They also note that as of late 1999 there was not yet
much information on performance on the firms in the NIFs.



18
financial policies, vibrant new entry, robust political competition, and the rudiments
of corporate governance in remaining SOEs provided (certainly) by the workers'
councils on the one hand, and (perhaps) by the professional and private NIF
managers on the other. Had any one of these mechanisms been absent, the
outcomes might have and probably would have been very different.    Since few
other countries, especially those to the east of Poland, possessed the
macroeconomic frameworks and vigorously exercised internal political competition
of Poland, it is not obvious that their adoption of slow privatization would have
produced equivalent results.
As for the World Bank, it did miss the potential of the workers' councils to
serve as a countervailing power-indeed, the only countervailing power at the level
of the firm-to managers. But it recognized fairly early on the utility and viability
of the alternative route the Poles had found and did not stand in the way of its
application.
V- Czechoslovakia
The first World Bank mission to then Czechoslovakia took place in May of
1990, a few months after the appraisal of the first Polish structural adjustment loan
by the Bank. For a variety of reasons, the Czechoslovaks borrowed hardly at all
from the World Bank for real sector reform; this remained the case for all
governments through the 1990s.36 But Bank staff entered into an active dialogue
with the privatization authorities, particularly in the Czech Republic, and kept up to
date on the approach they followed. Bank staff were generally (not universally)
persuaded as to the correctness and efficacy of the approach, often employed Czech
privatizers to preach elsewhere the gospel and techniques of voucher privatization,
and expended considerable effort in analyzing and understanding the method and its
effects. Thus, regardless of the lack of direct operational involvement, the path
followed in this country is worth analysis since it had a very significant influence
on the Bank's privatization efforts elsewhere in the region.
A different starting point....
Production in Czechoslovakia had been, along with that in the German
Democratic Republic, organized and managed in a most classic* socialist manner
almost up to the moment of the fall of the communist regime. Central planners and
branch ministries had retained their dominance. There were no quasi-market
mechanisms or small private firms along Hungarian lines, no powerful independent
labor union or workers' councils, or much decentralization to firm managers, or
private agricultural production, as in Poland, indeed, little experimentation with -
industrial cooperatives, leases and non-quota production, as in the Soviet Union.37
36 Vaclav Klaus, Minister of Finance of Czechoslovakia from 1990 to 1992, and Prime Minister of
the Czech Republic from 1992 to 1997, doubted the utility of World Bank involvement in the
economy. When asked if he needed international technical assistance, he famously replied, "Why
pay hard money for soft advice?"
37 Lajos Bokros portrays pre-transition Czechoslovakia as "a truly neo-stalinist stronghold until the
very last minute before the Velvet Revolution." For an excellent discussion of the importance of
initial conditions and much else, see his "Visegrad Twins' Diverging Paths to Relative Prosperity:
Comparing the Transition Experience of the Czech Republic and Hungary," Analysis based on a
lecture presented at the Czech National Bank, September 2000, p. 1.



19
The country, especially the "Czech lands" of Bohemia and Moravia-what
would become after 1992 the separated Czech Republic-had a long manufacturing
tradition and produced many comparatively high quality industrial goods for the
COMECON countries and some non-COMECON markets. Living standards were
about the highest in the socialist bloc and measured inequality about the lowest in
the world. Official unemployment in May of 1990 was 1,100-in a country of 16
million. Part of this comparatively good performance was due to the solid economic
base with which the country had entered the socialist period in 1948; part of it was
due to the intelligence and industry of the Czechoslovak work and managerial force.
As someone in the first mission said of the technocrats and plant managers
encountered, "these guys are so good they almost made socialism work."
At the last moment some cracks had appeared in the Stalinist walls:
Officials in Prague in May 1990 told the first Bank mission that from late 1988
workers in large firms were allowed to select their managers, from a list of three
presented to them by the branch ministry. They said they had regarded this as a
revolutionary change at the time. What was striking, however, was that the post-
communist regime reversed this decision in April of 1990, and reinstated
managerial appointment solely by the branch ministries. Why? Because "the
professors and researchers"38 who made up     the new   administration
accepted-unlike the Poles, with their longer history of struggle and suspicion and
the availability of alternatives-that it was the state that had to define and allocate
property rights.
Vaclav Klaus, at the time the Federal Minister of Finance, made this clear in
his first meeting with the Bank mission. He said that there was an acute need to
introduce both a private and a public sector. At the moment, he said, there was
neither, but only "a fuzzy sector in between." Defining the division between the
two was crucial for the future of the polity and the economy; and defining and
allocating property rights was the principal task that would confront the newly
constituted public sector.39 Privatization was the method by which property rights
would be assigned.
Mass privatization through vouchers....
The body responsible for this process was the newly constituted Board for
Temporary Administration and Privatization of State Property (later renamed the
National Property Fund), headed by an economist, Dusan Triska-who would
become the principal architect of the voucher scheme in the country, and a leading
proponent of its application elsewhere. In his first meeting with the mission he
expounded his leitmotiv; that the overarching purpose of privatization in post-
communist systems was to cut the link between the state and the productive firms.
Though written later (in 1992), the following summarizes Triska's position from the
outset:
Privatization.....is not just one of the many items on the economic program.
It is the transformation itself. Without a well-defined and feasible
privatization strategy the program would become just another hopeless
s Bokros, op. cit., p. 2.
39 Personal notes taken at mission meeting with Minister Klaus and his tearn, Prague, May 7, 1990.



20
attempt to reform the unreformable. Privatization is the element that
distinguishes transformation from reform. That is why privatization must be
conceived of and viewed as an end in itself.40
Triska had previously written that "In the highly improbable case that privatization
engenders-in the short run-declines in growth and efficiency, it would remain
the Government's policy to privatize.'41 Speed, he consistently stated, was of the
essence: "the faster the better."
In May 1990 Triska met with the first World Bank mission, and outlined
how the process would work: All SOEs would be transformed to joint stock
companies. This "commercialization" process would entail some financial
restructuring to clean or minimize debt and deal with eroded assets. This
restructuring would be the "last task" of the sectoral ministries; following this they
would be abolished (and they were).
The policy prerequisites for privatization were price liberalization, a
bankruptcy law, and convertibility of the currency. He stated that macroeconomic
changes, though necessary, would not be sufficient to alter or guarantee good SOE
performance. Therefore, privatization had to be widespread and quick to extend
and lock in the incentives coming from macroeconomic change. He explicitly put
forward the view that immediate action on divestiture was required despite the
imperfect policy and institutional foundation. Delay would simply allow those
presently stealing the assets to complete the job. "If we wait too long, there will be
nothing left to privatize." There would be no attempt to reform those firms
temporarily left in state hands; the solution was mass and rapid privatization.
How would this be done? Use of the methods applied in the West would
take too long, and place the mass of enterprises either in the hands of nomenklatura
who had stolen money in the communist period, or foreigners; neither outcome
would be acceptable. Rat-her, government would "give quite big portions of the
state property to the people,"42 for free, through vouchers. This program would,
said Triska:
>     Reward the public,
>     Help develop markets in general and capital markets in particular,
>     Deal with the problem of insufficient local savings and capital, and
>     Generate resources that would pay for the effort of producing information
on the firms being privatized.
"Everybody," said Triska, would be given vouchers (booklets of "coupons"
were eventually made available to all over the age of 18, for a fee equal to one
week's average wage), and we must now work out the many details of which firms
will be brought into the process, and how the vouchers will be exchanged for
shares. Still, he thought the process should be simple. Most people would probably
40 Dusan Triska, "Voucher Privatization in Czechoslovakia-1992," in Andreja Bohm and Marko
Simoneti, Eds. Privatization in Central and Eastern Europe 1992, op. cit., p. 104.
41 Dusan Triska and Charles Jelinek-Francis, "A Study of Privatization in the Czech and Slovak
Federal Republic," Bohm and Kreacic, op. cit., p. 119.
42 Personal mission notes, Prague, May 7 1990.



21
use their vouchers to buy shares in firms they knew, in their neighborhoods or in the
immediate vicinity.
The vouchers would not be convertible to currency, nor would they be
tradable (in fact, unlike in many other countries, the vouchers were not
denominated in currency units but in "points"); they did not want those with ill-
gotten gains to speculate and end up as major owners. Firms to enter the program
would be lightly evaluated to determine general prospects and attractiveness for
voucher-holders, but this and all other technical, preparatory processes would be,
must be, simple and quick. They were aware of the problem of selling off the
winners, leaving the state holding the losers. But, he said, who knows whether
today's loser could not be tomorrow's winner, as changes occur in the
macroeconomic framework, the trade regime, managers, etc.?
In this meeting Triska outlined the approach they would use to exchange
vouchers for shares. In essence, this consisted of rounds of bidding in which prices,
expressed in points per share, in the second and subsequent rounds rose or fell
according to the level of demand expressed in the previous round. Early bidders
had a high likelihood of getting the amount of equity they wanted, but at a relatively
high "price" (expressed in coupon points); later bidders might pay a lower price, but
ran the risk of less-than-desired quantity. This scheme was designed to equate
supply and demand in a situation of little information. The method was seen as fast,
equitable, and a solution to two vexing problems: how to value firms and how to
prevent "dirty money" from buying up the assets.
The Bank team was impressed with this presentation, but not completely
persuaded. A quotation from mission notes is in order, reflecting the team's various
reactions and questions. The scheme
...strikes one as cumbersome administratively. It doesn't guarantee
revenues, either for the enterprise-for restructuring-or for the
government-for financing the social safety net. It places an enormous
information burden on the public. People have to decide which enterprises
to bid on. They may have to do so in a distorted price and macro
environment which, when changed, will result in some seeming winners
becoming dreadful losers (and vice versa). Perhaps most important, this
scheme in general doesn't solve the problem of putting good managers in
charge of the resources.43
Triska dismissed all these queries, especially those concerns about whether
the public could make good choices and serve as good owners. Indeed, at one point
he asked if the World Bank lacked faith in markets. First, he said, "the present
system is more cumbersome, uninformed, unfinanced and unmanaged" than we
could imagine; almost any alternative was preferable. Second, we did not
understand the strength of the forces still existent in Czechoslovakia that were
opposed to rapid change. These opponents were espousing a seemingly reasonable
gradualism-but this was a cover for their desire for no change, or even a reversal
43 Personal mission notes, Prague, May 7 1990.



22
of transition.44 Delay would play into the hands of the anti-reformers. Third,
getting good owners with capital and know-how was important, but it must be the
second step. The imperative and essentially political, or indeed psychological, first
step was to get the firms out of the hands and implicit responsibility of government
and into the hands of private citizens. This crucial break with the communist past
had to be sweeping and rapid; if it were not, the transition would falter and perhaps
slide back.
In an argument later repeated and refined by Russian reformers, Triska
placed a lot of faith in the secondary market. He said that lack of capital and
managerial know-how would force the new owners to open the equity in the firms
obtained by vouchers to external investors having the needed skills and resources.
In other words, natural, automatic market forces would eventually supply monied
and experienced owners. Note that in this first, long and wide-ranging discussion,
no mention was made of investrnent funds.
The Rise of Czech voucher privatization...
It took the reformers somewhat longer than originally anticipated to get
started, but the privatization program was launched in 1991.45 From the outset it
was a homegrown product; the Bank's role was limited to that of an interested and
then increasingly impressed observer and commentator. By 1995 some 1800
medium and large firms had been privatized through two waves of a voucher
process. Another 350 enterprises had been sold on a trade sale basis to strategic
investors; and substantial assets had been transferred to local authorities or
restituted to identifiable owners who had suffered expropriation by the communists.
Public interest in vouchers was originally quite weak, but picked up
dramatically after dozens of private investment funds came into being, claiming
specialized information, promising to diversify risk, and in several cases
guaranteeing positive returns on any investment.46 Citizens responded by buying
vouchers, with 70 percent putting their vouchers into investment funds in the first
round, and slightly less in the second. At the end of the voucher exchange most
citizens thus held shares in an investment fund, and not in a specific firm; and the
investment funds became the major holders of all privatized equity.
The initial results were tremendously encouraging. Privatization contributed
to the rapid growth of the private sector share of GDP, which reached a region-
leading 74 percent by 1996. Exports shifted from Eastern to Western markets.
Growth resumed, having spent but a brief time in low negative territory, and topped
six percent in 1995. This transformation and growth were accompanied by single
digit inflation and, most surprisingly, extremely low rates of unemployment.
Compared to Poland and Hungary, with their initially high rates of unemployment
and difficult to contain inflation, the Czech Republic looked good. Compared to
44 Some opponents of rapid change advocated a "third way" to transition, somewhere between
socialism and rampant capitalism; this allowed Mr. Klaus to declaim: "The 'third way' is the
shortest route to the Third World." (Mission notes, May 1990)
45 As in Poland and Hungary, the mass of small firms and business units were auctioned off at an
early date, with generally positive results.
46 As noted, citizens had to pay about a week's wage to obtain the coupon booklet; the guarantee
offered by the investment funds was a multiple on that original purchase price.



23
Russia and many points east, it looked miraculous. By 1996 Prime Minister Klaus
could state that the transition was more or less complete and henceforth the Czech
Republic should be viewed as an ordinary European country undergoing ordinary
political and economic problems. He characterized the voucher privatization
program as "rapid and efficient."
Most observers and most World Bank staff working on the real sector in
transition agreed.47 The early and apparently resounding success story influenced
Bank staff in their recommendations on privatization in general and voucher use in
particular in a number of other transition countries. Table 2, below, shows the
principal and secondary methods of privatization employed in transition economies.
In nine of 26 reviewed countries vouchers were the prime divestiture method; in 10
they were the secondary method. In several instances, such as shall be shown for
Russia, the World Bank did not initiate the voucher idea; but in many cases the
Bank pushed for the use of this method. Moreover, it was quite clear in this period
that the Bank generally approved of the method and was willing and able to aid in
its implementation.48
In addition, in several cases, in Bulgaria (for sure) and possibly elsewhere,
the Bank employed the dynamic and persuasive Dusan Triska to explain the Czech
approach and techniques to seemingly reluctant or slow privatizers. Czech
representatives featured prominently in Bank-sponsored and supported seminars
and conferences of the period, disseminating what they increasingly assumed to be
"the" correct privatization method. The Bank's 1996 World Development Report
on transition noted some potential problems but concluded: "The Czech Republic's
mass privatization program has been the most successful to date.'49 In 1997, two
widely cited Bank research publications offered empirical data supporting the claim
that the Czech privatization prograrn was producing solid and positive results.50 The
point is that, in the mid-1990s, when one looked to the World Bank for guidance on
how to privatize in a transition setting, the Czech model was clearly the
recommended approach.
47 Not all; for example David Ellerman had long expressed doubts as to the utility of the approach,
and later wrote a strong critique of the approach; see his "Voucher Privatization and Investment
Funds: An Institutional Analysis," World Bank, Working Paper No. 1924, May 1998.
4 The Bank was not alone in this; most other donors, including the EBRD, the EU, USAID and
several other bilaterals, endorsed, advanced and supported this approach.
49 World Bank, WDR 1996, From Plan to Market, p. 56.
50 Roman Frydman et al., "Private Ownership and Corporate Performance: Some Lessons from
Transition Economies" (Washington, D.C. World Bank Technical Paper No. 1830, 1997), and
Gerhard Pohl et al., "Privatization and Restructuring in Central and Eastem Europe-Evidence and
Policy Options" (Washington, D.C. World Bank Technical Paper No. 368, 1997). Note that both of
these studies used firm level data dating from the first few years of transition. The data set analyzed
by Frydman et al. ran through 1994; Pohl and his team reviewed date through 1995 or 1996.



24
Table 2
Scope of Privatization & Method Used-1999
Country                    Large scale score*  Primary method       Secondary
method
(In descending order, according to
amount of privatization completed)
Czech Republic                    4             Voucher             Direct
Hungary                           4             Direct              MEBO
Slovakia                          4            Direct               Voucher
Estonia                           4             Direct              Voucher
Poland                            3.3           Direct              MEBO
Russia                            3.3           Voucher             Direct
Kyrgyzstan                        3             Voucher             MEBO
Lithuania                         3             Voucher             Direct
Georgia                           3.3           Voucher             Direct
Slovenia                          3.3          MEBO                 Voucher
Bulgaria                          3             Direct              Voucher
Croatia                           3             MEBO                Voucher
Kazakhstan                        3             Voucher             Direct
Latvia                            3             Direct              Voucher
Macedonia                         3             MEBO                Direct
Moldova                           3             Voucher             Direct
Armenia                           3             Voucher             MEBO
Romania                           2.7           MEBO                Voucher
Uzbekistan                        2.7           MEBO                Direct
Ukraine                           2.3           MEBO                Direct
Azerbaijan                        2             MEBO                Voucher
Albania                           2             MEBO                Voucher
Tajikistan                        2             Direct              Voucher
Turkmenistan                      1.7           MEBO                Direct
Belarus                           I             MEBO                Voucher
Bosnia                            NA            Voucher             Direct
Source for the scores and estimates of methods: EBRD, Transition Report 1999, p. 32.
* The score is the numerical ranking of the EBRD; its classification system for assessing progress in
large-scale privatization is: I - minimal progress; 2 - scheme ready for implementation; some
firms divested; 3 -  more than 25 % of assets privatized; 4-more than 50 % of assets privatized,
and substantial progress on corporate governance; 4+ - more than 75 % of assets in private hands;
standards and performance comparable to advanced industrial countries.
...and thefall.



25
While Poland and Hungary continued to enjoy four and five percent growth
rates, the Czech GDP growth rate fell by 40 percent in 1996, sunk to 0.3 percent in
1997, turned negative in 1998, and did not recover markedly until 2000.    Several
factors account for the prolonged slide, aspects of privatization among them. First,
the privatization investment funds were insufficiently regulated; this "opened the
door to a variety of highly dubious and some overtly illegal actions that enriched
fund managers at the expense of minority shareholders, and harmed the health of
the firm..." Second, some of the largest of these funds were owned by local banks,
which themselves were only partially or not at all privatized. Investment funds
owned by banks "tended not to treat aggressively poor performance in firms, since
pulling the plug would force the fund's bank owners to write down the resources
lent to these firms." 52 These banks, in turn, persisted in lending or rolling over
loans to poorly performing firms privatized by vouchers. As late as the summer of
1998, the CEO of one of the largest Czech banks stated that as "a national
institution"53 his bank could not ignore the needs of Czech industry, even in
instances where the appraisal numbers were weak.
The results were twofold: (i) The expropriation (called "tunneling") of firm
assets by investment fund and firm        managers54 defrauded many minority
shareholders and led to widespread public dissatisfaction with privatization, and (ii)
the tunneling, and deficiencies in the capital and financial markets, retarded needed
restructuring in the privatized firms, leaving them overstaffed, undercapitalized,
unable to raise investment funds, and poorly managed. The low unemployment rate,
formerly seen as a sign of success, began to be interpreted as an indicator of lack of
change in the firms.
An additional factor causing problems was that a number of foreign
portfolio and institutional investors had entered the Czech stock exchange,
anticipating steady positive returns on the privatized firms' and investment funds'
equities they obtained. As pervasive tunneling led to severe price drops in the
minority shares of many firms and funds, these investors were burned. Unlike most
Czechs, who could do little but grumble, the international investors could make a
great deal of noise, on the street, in the financial press and in meetings with
officials.55 The intemational image of the Czech Republic suffered.
51 At time of writing, in the first half of 2001 GDP growth rate in the Czech Republic is 3.9%;
versus 0.9% in Poland, and 4.0% in Hungary.
52 John Nellis, "Time to Rethink Privatization in Transition Economies?" in 0. Havrylyshyn and S.
Nsouli, editors, A Decade of Transition: Achievements and Challenges (Washington: IMF, 2001),
p. 170.
5 At the time of the interview this particular bank was, in theory, privatized. But government
retained 45% of the equity and another 15% was in the hands of local governments, and not
normally voted. Government thus remained the largest single and dominant shareholder; and this
was the case for the other major banks up to 1998, and beyond in some cases.
54 Given weaknesses in the legal framework, many of these acts were formally legal; thus, one
cannot use the term "theft."
55 Then Czech Minister of Finance Ivan Pilip attended a dinner in New York in 1997, given by a
group of Wall Street investment firms, the representatives of which complained of what they saw as
criminally poor regulation of Czech capital markets. They explicitly blamed Mr. Pilip and his
predecessors for the substantial losses this had caused them and their clients. Mr. Pilip was unfazed;



26
Academic papers began to appear, asking whether the voucher approach to
privatization was living up to its promises-or at least the implied promises. One
of the first critiques was by Pavel Mertlik, who in 1995 questioned both the extent
of privatization (noting the large amount of assets retained, directly or indirectly, by
the state), and whether the scheme was producing, or was even capable of
producing, concrete, good owners. 56 Criticism appeared of the investment funds,
arguing that their very design made it unlikely that they could or would "enhance
the value of their holdings."57 Another paper reviewed financial performance of a
set of firms and argued that there was no evidence that funds were managing shares
well; but the authors did find that "ownership concentration in hands other than
,,58
funds had a major and positive effect on performance.      That is, the set of Czech
companies initially privatized to core investors (often foreign) were generally doing
well, supporting Kornai's argument that the key to good privatization was finding
good owners. Subsequent research has largely confirmed that concentrated, core
owners-of the type produced by trade or "case-by-case" sales, but not by voucher
schemes that disburse ownership widely in a population-are associated with more,
faster and better restructuring59     though it may be that countries with good
policy frameworks attract core investors, while poor policy countries do not; and it
is the policy environment as much or more than the degree of ownership
concentration that accounts for the progress seen.
So, concentration of ownership is probably not the whole of the story. In
the Czech Republic and elsewhere, secondary trading, led by privatization
investment funds, did produce a high percentage of concentrated owners within two
he fielded their criticisms calmly and competently, arguing that the worst was over and corrective
mechanisms installed.
56 See Pavel Mertlik, "Czech Privatization: From Public Ownership to Public Ownership in Five
Years?" in Barbara Blaszcyck and Richard Woodward, Privatization in Post-Communist Countries
(Warsaw: Center for Social and Economic Research, 1996), pp. 117-21. Mr. Mertlik was a left-
leaning economist at the time he wrote the article, quite critical of privatization. In 1998 he became
Minister of Economy in the social democratic government elected in that year; he later became
Minister of Finance, where his policies and actions earned the high respect of the business and
international community. Mr. Mertlik resigned from the government in April of 2001, partly
because he was unable to convince his more interventionist cabinet colleagues to speed the few, but
very large and important, remaining privatizations, and partly due to his opposition to proposals to
subsidize ailing industries.
57 To its credit, it was the World Bank that published these criticisms; the citation is from Katherina
Pistor and Andrew Spicer, "Investment Funds and Mass Privatization: Lessons from Russia and the
Czech Republic," World Bank, Viewpoint No. 11 0, 1997.
58 A. Weiss and G. Nikitin, "Performance of Czech Companies by Ownership Structure," Boston
University, unpublished paper delivered to World Bank seminar, 1997, p. 21.
59 The most recent and rigorous analysis confirms the general (though not total) superiority of
private over state ownership, and among private owners, the superiority of concentrated over
diffused owners. Note that the data also reveal a large variation in results by subregion, with
privatizations in East and Central Europe and the Baltics yielding generally positive results, while
those in Russia and the other parts of the Commonwealth of Independent States (CIS) yielding much
poorer, and in a very few cases, negative results. See Simeon Djankov and Peter Murrell, The
Determinants of Enterprise Restructuring in Transition: An Assessment of the Evidence (World
Bank, September 2000). "Restructuring" refers to the cost cutting, efficiency- and competitiveness-
enhancing steps required to position a firm to survive and thrive in a market environment.



27
years of the voucher auctions." After the break-up of the federal state, the Meciar
government in now independent Slovakia abandoned the second round of voucher
privatization and turned over a mass of manufacturing firms, at very low prices and
with long payment periods, to concentrated owners-the bulk of them politically
connected to Mr. Meciar and his party. In both cases, and in others one could cite,
the resulting concentrated owners were not associated, at least in the short term,
with improvements in output, restructuring or probity.
The important point is while concentrated owners may be a necessary
condition for successful enterprise transformation; they are not a sufficient
condition. They have to be buttressed and guided by policy and regulatory
frameworks in capital and financial markets that shed light on corporate decisions
and actions, create and sustain proper procedures (regarding trading channels for
example), and offer protection to minority shareholders and creditors. Indeed, one
reason why direct foreign investment is so important is that the higher reputational
risk of such investors may lead them to adhere to decent behavior standards, even in
the absence of local regulations or enforcement capacity. The conclusion is that the
nature of the new owner is important, but so is the legal and institutional climate
into which the firm is divested.
By 1998 the bloom was very much off the Czech privatization rose, to the
point where an OECD country review could state bluntly that Czech voucher
privatization produced ownership structures that "...impeded efficient corporate
,,61
governance and restructuring.  Since that time, government has addressed the
deficiencies in the legislative and legal framework, particularly with regard to
investment funds and capital markets, privatized fully or more completely most of
the commercial banks, and started-but has not yet completed-the last remaining
large privatization projects, in electricity, energy, radio-television, and railways.
Implications
The implications of this brief review are several: From the viewpoint of the
Czech economy, one could argue that the application of the voucher approach
resulted in substantial losses and missed opportunities. The approach turned
over-planned or not-the bulk of the equity privatized by vouchers to investment
funds. This was combined with the insufficiency of prudential regulation in capital
and financial markets, the failure or inability to attend to corporate governance
concerns, the continuing state ownership and influence in the banking sector, and
the ownership of investment funds by banks. This mixture resulted in a small group
of people benefiting while the mass of citizens received little or nothing from the
transfer of former state property. Equally and perhaps more important, the
approach failed to impose sufficient constraints and incentives on the new owners
to restructure the firms. Kornai notes that labor productivity in Hungary in 1998
was 36 percent higher than in 1989; in Poland it was 29 percent higher. The Czech
Republic registered a six percent increase.62 It is reasonable to assign some of the
explanation for this to the mass privatization method.
60 Stijn Claessens and Simeon Djankov, "Ownership Concentration and Corporate Performance in
the Czech Republic," Journal of Comparative Economics, Vol. 27 (1999); see Table 1 B, p. 503.
61 OECD, The Czech Republic (Paris, OECD, 1998), p. 49.
62 Komai, "Ten Years After...," op. cit. pp. 10-11.



28
The average citizen's utility was probably increased more by the trade sales
than the voucher privatizations.63 Had the Czechs applied more widely this case-by-
case approach (as did Hungary and Estonia, for example) then one might have seen
faster restructuring, a less severe recession, and a smaller and less costly problem of
bad debts in the banks.
In response, the Czech architects of the program would downplay the costs
and criticisms of the voucher approach.64 They could note that the group of firms
sold by means other than vouchers were arguably the "blue chip" enterprises, of
high potential; and they could say that many of the companies privatized through
vouchers would not have attracted core, and certainly not foreign, investors. They
might argue that the option of leaving these firms in state hands was not open to
them, since, unlike the Poles, they had no workers' councils; that is, no
countervailing mechanism in the firms to watch over the managers. They could note
that concentrated owners did arise in fairly short order in many of the firms
privatized through vouchers. The Czechs could also say, look around the region and
note how very few countries have been able to mount good, extensive case-by-case
programs. The countries that have successfully applied case-by-case as their
principal sales method-East Germany, Estonia and Hungary-had different or
superior, and in the case of Germany, unique starting conditions, or, in the case of
Estonia, a situation where sales to foreign investors were welcome because of the
fear of Russian domination. On the larger political front, the Czech reformers could
state, correctly, that the near total collapse of communism was not predictable. One
could not have known at the outset how weak the forces of reaction would prove to
be, and how much time was thus available to experiment with ownership reform,
and to attend first to the institutional and legal foundations of privatization.
All these arguments have merit, though the conclusion is still that history
and geography endowed the Czechs with many more chances for direct, case-by-
63 In the sense that these privatized firms are among the most profitable, dynamic firms in the
economy, and, in contrast to most voucher-privatized firms, they have increased their workforces,
improved conditions of work, and generated growth among local suppliers. At least the Czechs did
sell a set of firms in this manner; the Russians did not-and are still paying the price for this.
Firms privatized to foreigners recently received support from an unusual source. In a seminar at the
Bank/Fund Annual Meetings in Prague in 2000, Mr. Richard Falbr, Secretary General of the Czech-
Moravian Trade Union Congress, stated that union members had opposed privatization in general
and privatization to foreigners in particular. Experience has led them to change their views, he said;
"we now see that the flag outside the building is less important than the quality of management
within." Falbr said that foreign owners, especially from multinational corporations, tended to be
easier to negotiate with than Czech owners, and more likely to accede to union demands.
640ne could expect a spirited defense of the approach taken. As an illustration, in a seminar in
Warsaw in late 1999 to review ten years of transition, Vaclav Klaus was asked to account for the
relative poor performance of the Czech economy vis-a-vis those of Poland and Hungary in the past
several years. He said first that the differences were quite minor and would be invisible and
unremembered in a few year's time, and second, that what economic problems existed in the Czech
economy were attributable solely to the excessively tight interest rate and monetary actions of the
independent Czech Central Bank, and not at all to the policies of his government, prior to his
stepping down from the Prime Ministership in November of 1997. At an earlier seminar (in
Ljubljana), when asked what he might change in his policies and approach in the light of experience,
he had answered, "nothing whatsoever."



29
case sales than they seized. The least that one can say is that opportunities were
missed.
From the point of view of the World Bank, the general infatuation with the
Czech voucher approach65 reveals a number of interesting points:
> The primacy of the economic. Here, and even more so in Russia, most Bank
staff tended to agree with those reformers who thought that ownership
change was ". . .not just a necessary condition of capitalism, but a sufficient
one."66 As several observers have noted, the primacy of the economic was
almost Marxian in its intensity. This led to the belief that
>  The required legal/institutionalframework would arise from demand by the
new, private property owners. Many reformers and their Bank supporters
did see the need, the urgent need, for legal, regulatory and administrative
mechanisms to channel and guide the acquisitive behavior of property
owners. But they hoped and believed that this increasingly populous and
powerful group would itself pressure government for, and support the
creation of, the required institutional framework. Bank staff generally
agreed with this reasoning, and tended to downplay or reject alternative
approaches because of
>  A strong bias towards concrete, substantial and near-term  action, as
opposed to necessarily less dramatic actions laying the foundation for future
developments. Voucher programs cut through the many and serious
obstacles/questions posed by direct sales. How to attract investors? How to
value the entities being sold? How to enforce contracts in the post-sale
period? Use of vouchers made it relatively easy to meet quantitative
conditionality targets on numbers of firms, or percentage of assets
privatized; other methods67 were slower, more complicated, and more prone
to delay. Bank operations and Bank staff had-and have-a predilection for
immediate and substantial action as opposed to longer term, "foundation
laying" measures. Thus, the reformers' arguments on the need for speedy
and massive transfers fell on receptive ears.
VI- Russia
From the very beginning it was clear that Russia would be a special and
more complex transition case, particularly with regard to real sector reform. Poland
and the Czech Republic were geographically and historically part of central Europe,
with long-standing commercial, legal and institutional ties with Western markets
and cultures. Both were part of the communist bloc for about 40 years, meaning
that there were plenty of citizens in both countries who remembered the non-
communist past. Both could dust off old laws and memories and try to re-start a
rusty but not completely forgotten system.
65 This author was among the infatuated.
66 Komai, "Ten Years After....," op. cit. p. 15.
67 Management-employee buy outs (MEBOs) were also relatively simple and fast, especially when
installment purchases were allowed or encouraged, as they were in Romania, Slovenia, Croatia and
elsewhere; see Table 2. There is little evidence that this divestiture method is associated with
extensive post-sale restructuring.



30
This was not the case in Russia. Its socialist experience had endured for
more than 70 years. In any event, despite considerable progressive strides in the
twenty years prior to the Revolution, Russia was not a full-fledged capitalist system
in 1917. This heritage resulted in much more uncertainty at the end of the socialist
period than in countries farther to the west.
First contact....
The first Bank mission (in conjunction with the Fund, the European Bank
for Reconstruction and Development, and the Organization for Economic
Cooperation and Development) to the then Soviet Union took place in September-
October of 1990. Regarding enterprises, it found confusion. There were,
reportedly, 47,000 medium and large-sized industrial firms in the Soviet Union as a
whole; adding the energy, infrastructure and large service-oriented firms brought
the number to 55,000. Many of these were classed as "amalgamations,"
"associations" and "concerns;" that is, multidivisional entities containing subunits
that could be regarded as self-standing companies. This meant that the actual
number of state-owned productive units was higher than the official numbers
indicated.
As in some other socialist states, the way in which these enterprises
functioned had been evolving, slowly in the 1960s and 70s, and then much more
rapidly in the mid-1980s with the advent of Gorbachev's perestroika -reforms. A
1987 Law on State Enterprises reduced the power of the branch ministries in favor
of enterprise managers and workers. Firmns were given an increased capacity to
negotiate planned annual production, modify products to meet consumer demand,
market their products abroad, contract with foreign partners, retain an increased
amount of any foreign exchange earned, and allowed to look for credit outside the
traditional funding sources. Some enterprises had won the privilege to sell some or
all their production to any willing buyer, at a more or less "market" price; this
privilege was to be expanded. "The goals of these changes were to decentralize
some decision-making to the level of the firm, to widen the scope for personal and
private initiatives, and to substitute (partially) indirect financial signals for direct
,,68
planning as a means to guide enterprises.  It was already clear at the time that
the managers had gained most of the controlling power in this shift; other than
make claims for wage increases, workers tended to defer to managerial decisions.
The 1987 law also allowed increased latitude for nonstate forms of
enterprises; i.e., joint ventures, leases, cooperatives, "collectively owned" and
"limited" firms. Data were scant on the exact organization, total number and
impact of nonstate firms, but it was thought that these tended to be small in size, -
growing in number, and more productive than the larger enterprises out of which
they had been spun. Spokespersons in the cooperative movement claimed 215,000
units in existence in October 1990, accounting for five percent of "net material
product," employing 5.2 million people, registering huge output and employment
increases in the past two years, and growing rapidly. Another source stated that
12,500 leasing arrangements were officially registered, and estimated that many
more were in informal existence. Enterprise interviews revealed one or more leases
(8 John Nellis, Improving the Performance of Soviet Enterprises, World Bank Discussion Paper
No. 118, March 1991, p. 3.



31
or cooperatives in every firm visited, and the contrast was striking between the
dynamism and enthusiasm shown by managers and workers in these units and the
lethargy generally prevailing elsewhere-not surprising, given that employees in
these nonstate units escaped the wage caps that still were applied in the traditional
firms.
Some have argued that these promising developments should have been
greatly encouraged and extended, and, had that been done, that the nonstate
sector-operating somewhere in between private and public ownership-could
have evolved and become, as it did in China, a major contributor to employment
and growth.69 The implication is that the subsequent dismantlement of the real
sector and the attempt to reconstruct it in largely privatized fashion was both unwise
and unnecessary, and that a less revolutionary, less painful, more incremental and
productive path had been available, and should have been chosen.
That was not the way the IFI mission saw it:
A process of spontaneous privatization is taking place in large sectors of
industry through the leasing of facilities to cooperatives consisting of the
managers and workers of state enterprises. Given the uncertainty of
ownership rights, including the right to sell enterprise assets, the incentives
of the new managers tend towards short-term income maximization at the
cost of enterprise decapitalization.70
The IFI mission assessed the nonstate sector as an improvement, in incentive and
productive terms, over SOEs, but as an inadequate and improper basis for long-term
growth and transition. Inadequate because the lessees, and those in cooperatives,
controlled the assets (liabilities remained in the parent firms) but did not own them;
and it was apparent that the weakened state was in no position to monitor and
enforce the obligations of the lessees to maintain the health of the assets. Improper
because it seemed clear that managers in SOEs were using their new-found latitude
to hive off the higher quality assets in their firms to leases and coops in which they
personally had a stake. Nonstate activities thus appeared to be thinly disguised
expropriation of good assets by managers and favored groups of workers, and not a
foundation on which one could base a policy of real sector reform.
69 This is the general argument of Peter Nolan, for example. "Tragically, the Soviet economic system
had a large potential for improvement under a suitable set of incremental reforms. It was not
necessary for there to be a period of 'surgery' and steep decline of output and living standards before
improvement set in." See his China's Rise, Russia's Fanl (New York: St. Martin's Press, 1995), p.
311. He adds, however, that "...successful implementation of such policies required the maintenance
of a strong and effective state apparatus..." without indicating just how that last, crucial political
condition could have been fulfilled. Specifically with regard to unleashing the Russian lease-holders
and cooperatives, Joseph Stiglitz later argued that "(R)eformers who recognize that real
transformation requires participation and involvement would have welcomed this reform movement
and would have pushed it all the way to full privatization .... In Russia, the leasing movement was
stopped dead in its tracks in favor of voucher privatization." "Whither Reform? Ten Years of the
Transition," paper delivered at the Annual Bank Conference on Development Economics,
Washington, April 1999, p. 24. More discussion on Stiglitz's arguments is offered below.
70 The Economy of the USSR, op. cit. p. 26.



32
In view of the tremendous contribution to investment, production and
growth made by nonstate firms operating under what has been termed "fuzzy
property rights" in China,71 it is possible that an opportunity was missed in not
pushing harder for a general unleashing of these halfway measures to private
industrial ownership. But the conditions prevailing in Russia were quite different
from those in China, where fairly well-functioning local governments were able to
subject nonstate firms to competition, and had the capacity and authority to step in
and correct at least some of the most egregious self-enrichment by firm managers,
and where the central state could impose some discipline and penalties on the
72
flagrantly corrupt.   Since that was decidedly not the case in Russia,         a
recommendation to follow this approach (it probably would not have been adopted
even if recommended; but that is another story entirely) would likely have resulted
in the further empowerment of managers. In the absence of competitive and
institutional checks on their behavior, this probably would have produced neither
production gains nor social benefits. One cannot say for sure, but it was not then
thought ( and I do not think now) that this approach would have worked.
Thus, the real sector reform policies advanced by the 1990 IFI report were
(i) eventual full privatization of "almost all enterprises in the USSR." Concluding
that this was a long-term proposition, the report called for demonopolization and
commercialization of the SOEs, the imposition of hard budgets, and efforts to
approximate the effects of private sector management through state holding
companies.73  In the final analysis, the issue became moot: the impact of these
recommendations was nil, as the political disintegration of the Soviet Union, and
the rebirth of Russia, occupied center stage from the end of 1990 through to the fall
of 1991.
The Mass Privatization Program....
As the political dust settled, the World Bank was called back to Russia, in
November of 1991, to assist the newly appointed Gaidar government in its
privatization efforts. It found this government thoroughly committed to the concept
of privatization; leading officials entertained no hopes that one could reform state
firms by means other than divestiture. There was thus no interest in state holding
companies, performance improvement in SOEs, or any other halfway houses such
as leasing and cooperatives. However, exactly how privatization should and could
proceed was unclear.
7 The extent and nature of the Chinese nonstate sector's contribution was not fully documented in
1990, but enough was known-much of it from World Bank research and reports-to make it
plausible that one might have made a recommendation to follow this path.
72 Peter Murrell characterizes, in an admittedly exaggerated manner, the distinction in approach at
the end of the 1980s in the two countries as follows: "The Chinese were given a license to compete
and a death sentence for stealing; the Russians were given a license to steal and punishments for
competing." (Personal communication, July 2001) This lends weight to the interpretation of the
situation in the IFI report.
73 The Economy of the USSR, op. cit. pp. 26-28. In light of later events, it is worthwhile to quote
the report's statement on mass privatization through vouchers. While acknowledging that their use
could speed up ownership transfer, "....such giveaways have a number of disadvantages. Most
importantly a voucher system would result in widely scattered ownership which would be unlikely to
result in effective monitoring of enterprise managers." (p. 26)



33
The govemrnent had recently appointed a new head and assistant head of the
State Committee for Property Management (GKI, from its Russian initials; this later
became a Ministry, or MKI), one of the bodies responsible for privatization; these
were Anatoli Chubais and Dmitri Vasiliev, both from Leningrad (as it still was), the
leading reform city in the country; they were producing a plan of action. As in
Czechoslovakia, these officials had been "professors and researchers." They had
some legislative base to guide them: In July of 1991 (before the final collapse of
the USSR) the Russian Supreme Soviet had passed two relevant laws; one on
Privatization of State and Municipal Enterprises in the Russian Federation, the
second on Personal Privatization Accounts. Neither law was terribly detailed. The
Privatization act established that government must submit to the legislature an
annual program specifying what would-and what would not-be divested, and in
what manner. It assigned management responsibility for parts of the process to
several different bodies, but there appeared to be considerable overlap in the
responsibilities. It gave enterprise workers collectives the power to approve or
reject, or at least delay, privatization proposals. It said very little about foreign
investment and ownership. The second act vaguely indicated that "investment
certificates" would be distributed to all citizens for use in the privatization process.
In the troubled political situation after August 1991, nothing had been done
to implement these laws. In late October, Yeltsin announced that privatization must
now go forward. Debate intensified over how to proceed. The threat of a
communist resurgence was palpable, much more so than in Poland or
Czechoslovakia. The attempted coup had taken place in August of 1991, and the
only slightly reformed Communist Party was still a major presence in the legislature
and, for all one knew, in society at large. The reformers argued that speedy and
decisive action was required, but-as in Poland-the various key actors in the
process had differing and often competing ideas. Workers, managers, branch
ministries (rapidly transforming themselves into "industrial associations"), and the
sub-national govemments were all putting forward claims.
The November 1991 Bank mission gravitated naturally towards dealing with
and supporting the GKI. The July law assigned it (more or less) the prime
responsibility for policy-making and program design. Its leaders were young, clear-
headed, market-oriented reformers who saw their primary objective as advancing
privatization rapidly and transparently. It was the only agency the mission
encountered that was using high quality, obviously competent technical assistance;
and the leaders had already established contact with supportive and enthusiastic
Westem academic advisors-who were marshalling financial and technical support
for the organization. Thus, the GKI had the authority, the vision (what seemed to
us the proper vision, one might add) and the capacity to act; and the World Bank
began at this time its long relationship with this agency and its ministerial
successor.
In the November 1991 meeting Dmitri Vasiliev had stated an aversion to
vouchers, but by April of 1992 a mass privatization program had been defined,
cleared by the executive and submitted to the legislature, with vouchers as the
centerpiece. The now-familiar and overpowering logic was at work: Sales for cash
would be too slow, would exclude the bulk of the populace, and thus might



34
stimulate political opposition to privatization in particular and reform in general.
Giving away shares only to the workers in that particular firm was fine if the firm
were a winner; otherwise not. Moreover, this policy would exclude the military,
civil servants and professionals from ownership. A mass program based on
vouchers for all citizens seemed the only available way to deal with these concerns.
This reasoning was accepted, and the reformers and their supporters swung
into action. Between the spring of 1992 and the end of June 1994, the Russian
authorities-actively supported by the Bank, the IFC, the EBRD, USAID and the
EU, and with important smaller inputs from other donor organizations such as the
British Know-How Fund-organized and implemented the largest and fastest
privatization program ever seen, then or since.
In just two years the Russian government was able to....: (1) corporatize and
register over 24,000 medium and large state-owned enterprises as joint stock
companies; (2) distribute vouchers to virtually the entire population in some
89 oblasts, territories and autonomous republics; (3) privatize over 16,500
enterprises, most of which were in the tradable sector. Over forty-one
million Russian citizens became shareholders through either direct
ownership of shares in the newly privatized companies or share ownership
in voucher investment funds. Moreover, private hands control more than
fifty percent of Russia's industrial production and twenty-two million
workers are employed by private enterprises.74
These accomplishments came at a price: The need to reward the key stakeholders
had led to firm managers and workers, "insiders" as they became known, ending up
with a dominant 2/3 of the shares in about 2/3 of all firms divested.75
The World Bank was deeply involved in every step in this process. In the
crucial policy-making days of December 1991 and January 1992 the IFC Resident
Representative in Moscow (the only Bank group person consistently on the scene)
had provided and channeled advice and badly needed logistical support; IFC's
critical contribution needs to be acknowledged. The IFC later became the primary
supporting force for the extensive and highly regarded program of small-scale
privatization through auctions, in Nizhny Novgorod and other Russian cities. (As is
generally the case, few Russians were or are troubled by small-scale privatization.)
From mid-1992 on, there were frequent Bank missions to prepare a Privatization
Implementation Technical Assistance loan, in the course of which advice and
74 Ira Lieberman and Rogi Veimetra, "The Rush for State Shares in the 'Klondyke' of Wild East
Capitalism: Loans-for-Shares Transactions in Russia," George Washington Journal of
International Law and Economics (Vol. 29, No. 3), 1996, p. 739.
75 For a discussion of the politics of the process see Andrei Shleifer and Daniel Treisman, Without
A Map: Political Tactics and Economic Reform in Russia (Cambridge: MIT Press, 2000).
Shleifer was a key participant in the process; see his earlier (with Maxim Boycko and Robert
Vishny) Privatizing Russia (Cambridge: MIT Press, 1995). For data on the outcomes of voucher
privatization see Joseph Blasi el al Kremlin Capitalism: Privatizing the Russian Economy
(Ithaca: Comell University Press, 1997). Note that the reformers had taken some steps to prevent
insider dominance, but had been defeated on this matter by the need to bring stakeholders on
board, and by the high rate of inflation, which wiped out the financial barriers they had tried to
erect against insider control.



35
assistance was provided on the design, mechanics, production, distribution and use
of the vouchers; on a wide range of matters related to preparing the selected firms
for entry into voucher auctions and the mechanics of the auctions themselves; on
the gamut of issues surrounding the distribution, registration and recording of
shares; on a host of legal concerns that arose; on assisting a "National Auction
Process" in 80 participating oblasts; in managing the cash sales that accompanied
the voucher auctions; and in helping staff, furnish, promote and defend the GKI.
The Bank, jointly with the EBRD, in 1992 prepared and negotiated this loan
of close to $100 million. Disbursements were seriously held up by political and
legal issues in Russia, and by Russia's ability to generate much of its needed TA
through grant-funds. USAID (and others) then undertook many of the privatization
assistance activities, but all involved acknowledged their reliance on the detailed
appraisal and tactics established by the Bank and set out in the loan documents.
The point is that the extent of the support provided by the Bank to the Russian MPP
cannot be discerned simply by reviewing disbursals. The sums in the first Bank
privatization assistance loan were, I believe, transferred to other, later privatization
efforts, to consolidate and extend the MPP, and move into the next, post-voucher
phases of privatization-parts of which are discussed below
At the end of the voucher privatization effort in 1994 almost all involved
assessed the experience as positive. Dmitri Vasiliev summed up the "basic lessons"
for those starting later:
> Privatization should be carried out in the "shortest possible period of time,
using... .the simplest and most standard procedures..."
> "Restructuring should be postponed until the completion of privatization."
> "The maximum possible amount of property should be transferred to the
population on a free basis."
> Incentives should be provided to enlist the support of all important
stakeholders, including "workers, managers, population, officers of
privatization bodies, local authorities..."
He acknowledged the need to create "a securities market... .to provide the
reallocation of property rights to efficient owners following privatization,"76 and
that "deep institutional changes" were required for privatization to bear fruit. Still,
the implication was that the required institutional changes were on the way and
would appear in the foreseeable future. His central message was that Russia's
experience "proved that countries in transition...can make efficient.use of voucher
privatization methods."77
Anatoli Chubais and his principal advisor, Maxim Boycko, agreed; they
stated-in a June 1994 celebratory conference on Russian privatization held in
Washington at the World Bank-that the unprecedented Russian mass privatization
program had successfully achieved its principal goals of removing firms from the
control of politicians, and creating a constituency for a market economy.
76 Dmitri Vasiliev, "Privatization in Russia-1994," in Andreja Bohm, ed., Privatization in Central
and Eastern Europe 1994 (Ljubljana: Central and Eastem European Privatization Network,
1995), pp. 372-3.
" Ibid., p. 372.



36
The summer of 1994 was the high water mark for mass and rapid
privatization in Russia. The program had been carried out with remarkable speed
and efficiency, in a fairly transparent manner (compared to what followed), and the
contributions of the World Bank had been important and acknowledged. The
program seemed to justify the view of privatization as an end in itself, essential to
severing the links between enterprises and the state. The characteristics of the
optimal method of divestiture were speed, simplicity, and breadth of application.
The risks-that neither corporate governance nor restructuring would initially be
optimized-of privatizing to a set of diffused and inexperienced owners were
recognized. Reformers and Bank staff called for legal and institutional measures to
promote and regulate secondary trading. But as in the Czech Republic, the
assumptions were that (i) the reformers in power could and would initiate this
institutional change, and (ii) that the new group of private property owners created
by mass privatization would constitute an active lobby, pressuring and assisting
governments to both pass the required laws, and back the new legislation with the
will and resources required to make the laws effective. And-again, as in the Czech
conception-financial need stemming from "depoliticization" and the demise of
soft government money (imposition of a hard budget constraint) would force
secondary trading among the capital-short insider owners, opening these firms to
competent, concentrated ownership, and setting them on the path to restructuring
and growth.
The prevailing attitude among involved Bank staff generally matched the
positive view of the Russian reform team-tempered by a realization that the bulk
of equity had been transferred to insiders, and that there was a substantial amount of
state assets that the program had not touched. This led to acknowledgement of the
considerable ground still left to cover.
Transfer to insiders was a striking step, but only a first step. It must now be
followed by equally essential second steps opening ownership of privatized
firms to external investors and owners. These.. .will complete the
restructuring of firms begun by the transfer of ownership... .Such is the
hope .much stands in the way in the achievement of this grand
aspiration... .Insiders fear that the restructuring brought about by external
investors will cost them their jobs; thus, they do their best to prevent or
minimize sales of large blocks of share to external investors.....12,000-
14,000 enterprises remain uncorporatized, unprivatized .... what will happen
to this important set of firms?78
Problems.....
Optimism concerning Russian privatization did not take long to fade. In
July of 1994 the Russian parliament rejected government's proposed second phase
program. The program was promptly promulgated by presidential decree, and
while this solved the problem in the short-run, the frequent use of such decrees gave
78 John Nellis, "Introduction," in Lieberman and Nellis, Russia: Creating Private Enterprises
and Efficient Markets, op. cit., pp. 2-3 (containing the papers presented at the World Bank June
1994 conference on Russian privatization).



37
ammunition to those who claimed privatization was being foisted upon an
uncomprehending, unwilling polity.
In 1995, production failed to recover, few external and even fewer foreign
investors became involved in secondary