Download Primary Privatization Goal in Economies in Transition

Primary Privatization Goal in Economies in Transition
Dušan Mramor
Associate Professor of Finance
Faculty of Economics, University of Ljubljana
Kardeljeva ploscad 17
1000 Ljubljana
Slovenia
(+386 61) 189-2442
Fax: (+386 61) 189-2698
Email: [email protected]
Ljubljana, September 7, 1996
Primary Privatization Goal in Economies in Transition1
Abstract
The paper argues that economic efficiency is not the primary goal of the "voucher" type
models of transition from former "command" to market economies. The primary goal of the
transition process based on these models is redistribution of wealth and finance is used as a
tool for this redistribution. With the most widely used model, named by the author as the
"miracle" model, the primary goal of redistribution of national wealth to specific groups of
citizens and foreigners is achieved in five stages: distribution, regulation and three
redistribution stages. Only after the redistribution stages are completed, will economic
efficiency become the primary issue.
Introduction
1
The author wishes to thank for useful comments on prior versions of this manuscript
to Neil Garrod, Robert Klemkosky, Roger Koopl, Elton McGoun and William Sartoris. The
usual disclaimer applies.
1
There is a widespread belief among economists that the change of economic system in former
"command" type economies is inevitable and that the main goal of the change is economic
efficiency. From the microeconomic perspective the former state, that is, the social type of
incentives and ownership, should be changed to a more efficient private type. From the
macroeconomic perspective it is of primary importance that a command savings and
investment process is replaced with a well functioning financial system. To achieve the
highest degree of economic efficiency in the shortest period possible, the process of transition
should also ensure the highest possible degree of macroeconomic stability.2 A number of
theoretical models of transition were developed, a few of them were used in practice, and for
all of them it was claimed that their implementation would result in economic efficiency. But
it is the author's view that the primary goal of the models most frequently applied in countries
in transition is not economic efficiency. The primary goal of the transition process based on
these models is not value creation but redistribution of wealth and finance is used as a tool to
achieve it. 3
Superior privatization models from the economic efficiency point of view
offered by some economists were not politically acceptable, therefore, we can expect
important micro and macroeconomic inefficiencies in the transition period.
This paper is a description of the process of transition in former socialist countries with the
focus on its primary goal - the redistribution of wealth, on how finance is used to accomplish
it and what are the consequences for economic efficiency in the transition period. Besides the
analysis of actual developments in these countries from the perspective of redistribution, the
paper also describes the logic of foreign and domestic advisors and decision makers, as it was
2
This assumes at least certain degree of political stability. Usually political stability is
questionable if there is a general perception of great unfairness of the process of privatization.
Therefore, the model of privatization should also ensure, that the general perception of
unfairness is not of a magnitude that would be politically damaging.
3
Models of transition differ among countries in details, but in general they are all
based either on the "sale" or the "distribution" method of privatization. The "sale" method
assumes the sale of state capital to private domestic or foreign investors, while with the
"distribution" method the state capital is distributed to domestic citizens (primarily with
vouchers) or institutions (like pension funds, restitution funds, etc.). Country by country a
short summary of the privatization methods used is presented in the Transition Report (1994,
p.16-41), and more detailed information can be found in annual publications by CEEPN,
Privatization in Central & Eastern Europe (1991-1995).
2
revealed to the author either through his direct contacts with these advisors and decision
makers or through their written suggestions and explanations.
In order to present the general logic the details and modalities of the transition process are
ignored, and explanations are based on the most broadly used transition model - the voucher
type "distribution" method of privatization, however, the main logic of redistribution of
wealth is also similar for most of other models used so far.4 In the first stage of this model,
which is called by the author a "miracle" model, most of national wealth in the form of shares
of equity of state companies is distributed among citizens. In the second, so called
"consolidation of ownership" stage, it is argued that the wealth is redistributed by selling
shares at depressed prices, resulting in more concentrated ownership. The third stage ensures
the regulatory infrastructure that the model requires and the fourth stage is shown as a stage
of further redistribution. Macroeconomic imbalances of increased consumption and decreased
savings resulting from the implementation of the model lead to the sale of equity to some
domestic but before all to foreign investors at prices much lower than fundamental values.
The fifth stage is presented as the phase of final redistribution which is achieved by
manipulation and speculation on inefficient capital markets of countries in transition.
The core of the paper presents and analyses the five stages.
Stage I - From state (social) to private ownership (distribution)
4
Countries in transition are in different phases of the transition process. This paper
refers to the most advanced of these countries. It is our understanding, that others will follow
along the same lines.
3
Having in mind the enthusiasm for democracy and capitalism present among citizens of
former socialist countries at the time of collapse of the old political system, it was not hard
for the new class of politicians to portray the change primarily as a step from a less efficient
"command" economy to a more efficient market economy of many opportunities. Private (not
state or "social") initiative was presented by these politicians as the "deus ex machina" that
will almost instantly enable everybody to live better, and this view was strongly supported by
a number of foreign economic advisers.5 In this first stage, many foreign advisors vigorously
"pushed" the idea that overall private ownership is a necessary and sufficient precondition for
private initiative to burst and release the market forces of development.6 The newly elected
politicians were at first more or less reluctant to introduce private ownership too quickly
because of the many unknowns, but quite a number of them changed their minds when they
were offered the "miracle" model by some primarily foreign economic advisers.7
The model, as it was presented by foreign advisors, was quite simple. The "big picture" of
private ownership, primarily the structure found in the US, was used as the target ownership
structure for the large and midsize companies in the country in transition.8 It was proclaimed
5
An excellent description of general atmosphere and beliefs in Russia at the beginning
of their "voucher" privatization was presented at the Securities Market Forum in London
(Sept.7-8, 1996) by Igor Bazhan, First Deputy Chief of Federal Commission on Securities
Markets, Russia, concluding: "We were expecting that immediately after privatization
everything will be well, technologically and concerning restructuring."
6
In his book Stiglitz (1995) says that privatization has fallen under the spell of the:
"...property myth...(which) holds that all one has to do is correctly assign property rights, and
economic efficiency is assured. This myth is a dangerous one because it has misled many
countries in transition to focus on property rights issues, on privatization, rather than on
broader set of issues. Resolving property rights is certainly not sufficient, and may not even
be necessary."
7
We use the name "miracle" model for the transition model based on voucher type of
mass privatization method. The written and oral proposals for the transition model based on
this public distribution method of privatization date back to the late 80s, but its final version
(which includes "privatization" funds) is usually connected with the name of its vigorous
advocate Jeffrey Sachs of Harvard University. A short presentation by early proponents of
this model can be found in Lipton & Sachs (1991, p. 26)
8
In this first stage the "big picture" primarily refers to the ownership structure of the
U.S. corporate sector - the majority of shares of companies owned by institutional investors
(mainly investment funds) and the rest by individual shareholders.
4
that such an ownership structure would ensure efficient corporate governance. Reaching this
goal at the highest possible speed was the primary objective.9 The "miracle" part of the model
was the idea to first transform all (or a considerable number of the larger) companies into
public corporations and then distribute their shares to citizens. To ensure "fairness"of the
process government would issue vouchers and the citizens would receive them (free of charge
or at a symbolic price) with a free choice of exchanging them for shares of corporations or for
shares of privatization funds. Privatization funds would then exchange accumulated vouchers
for the shares of corporations.10
This is politically a very "marketable" model, as:
a) politicians gain popularity with the possibility of offering something to all their voters,
b) it appears fair, as everybody receives an equal share of something that was previously
owned by all citizens,
c) it offers opportunities to everyone, as everyone has the right to choose where to invest his
or her voucher,
d) it gives an impression, that it is possible to literally jump from a "command" economy to a
market economy and to the standard of living in developed Western countries, and
9
It was argued that speed is extremely important to reap the full benefits of private
ownership, and this was underlined with the argument that "... unless hundreds of large firms
in each country are brought quickly into the privatization process, the political battle over
privatization will soon lead to a stalemate in the entire process, with the devastating
long-term result that little privatization takes place at all." (Lipton&Sachs, 1991, p. 27)
10
In some countries vouchers were tradable, and in some they were not. In this paper
we assume, that vouchers are not tradable (they can only be exchanged for shares of
corporations or investment funds by the original owner of vouchers). If vouchers are tradable,
than this stage of the process represents the distribution of vouchers, while the selling and
buying of vouchers is already the second stage of transition process.
5
e) it is very much aligned with the interests of potential foreign and domestic strategic and
portfolio investors.11
The main tool of this model is a special type of capital market, where shares of the companies
are traded for vouchers. In this way, stock market, represented in the minds of citizens of the
"transforming" countries by financial wizards of US capital markets who became immensely
rich over night, was already in the first stage used as a tool to increase the interest and support
for this model. Other, from economic perspective superior privatization models, could not
compete with the "miracle" model from the perspective of political attractiveness.12
Stage II - Adequate ownership structure and the role of capital market (first
redistribution)
When the "miracle " model was proposed a number of economists opposed it, arguing that it
is unable to provide adequate corporate governance. For example, Kornai (1990, p.82)
argues, that:
"The point now is not to hand out the property, but rather to place it in the hands of a
really better owner.",
following the logic, that only adequate owners (ownership structure) can assure that the most
capable will become managers and manage companies well.
The proponents of the "miracle" model were at first replying that:
"The process can be accelerated through the free distribution of shares in a manner
11
One should not neglect the fact, that if the decision to implement such a model of
fast privatization was accepted, quite substantial foreign funds for "technical assistance" were
available for the use of foreign advisors. As domestic knowledge of market system
economics, law etc. was limited, foreign advisors were more or less a necessity for the
"successful" completion of transition.
12
Regarding the potential economic efficiency (and even social fairness) of the process
and final result, the model proposed by Ribnikar (1994, pp.93-108) was undoubtedly
superior, but it lost in a political competition with the "miracle" model. The essence of
Ribnikar's model is, that privatization should be primarily achieved with new equity
investments in companies, while existing nonprivate capital should be transformed into
preferred shares and allocated to "institutions of a public character", for instance the state
pension fund, ecological fund etc.
6
consistent with the development of the effective ownership."(Lipton&Sachs, 1991, p.27).
However, after the first stage, when the shares of companies were already privately owned by
investment funds or individuals, it became clear that this "big picture" ownership structure
does not ensure economic efficiency and that restructuring of ownership is necessary.
What the authors of the "miracle" model actually offered was an old solution for the tricky
question of the achievement of optimal ownership structure in each company. The solution
was again very simple - the so called "consolidation" of ownership is to be achieved by
market forces on the capital market. 13 It was suggested, that in order to enable quick
"consolidation",
a technically well developed capital market would be needed with
appropriate stock exchanges with electronic trading, dematerialization of shares, central
clearing and depositary institutions, transparency etc. Along this lines of reasoning, out of the
most important elements of efficient capital markets, the depth and breath of the market, are
usually not mentioned as very important, while the stability of the market (circuit breakers,
limitations on daily price changes, different interventions etc.) is not considered and any
measures to attain it is regarded as administrative and devastating for the functioning of the
market.14
13
In the early written and oral proposals of the public distribution method of
privatization in late 80s the inappropriate ownership structure that resulted from such
privatization was usually recognized. But it was the widespread belief among the proponents,
that it would be "corrected" by market forces with trading on the secondary capital market see Lipton&Sachs (1991, p.26).
14
Such summarized suggestions for creating a capital market in countries in transition
are presented in Pohl et all (1995).
7
The fact is that the "miracle" model did facilitate at least the first phase of "consolidation".
The wealth and GDP per capita in countries in transition are still low and relatively evenly
distributed. Therefore, a great majority of households has low income and a comparably low
propensity to hold their savings in the form of shares as their risk aversion is high. This
should help the "consolidation" as the majority of original voucher recipients would be more
than willing to sell shares and would not be very price sensitive, as the price they paid for the
shares was little or nothing.15
The proponents of the model made a questionable assumption, that "privatization" funds are
appropriate owners (i.e. Laštovi_ka et all, 1995, p.201-207) and did not answer the question
of what ensures that the buyers of shares from the original owners in the secondary capital
market are appropriate owners. But the question is not a relevant one from the perspective of
this paper, as our point is that the essential goal of the "miracle" model is not economic
efficiency.16
15
The results of personal interviews concerning the privatization process in Slovenia
with 1133 Slovenian households in July 1995 by Agency Kline & Kline revealed that the
majority of households (54.6%) was willing to sell shares obtained through vouchers when
they became freely transferable for less than 66% of their real value (Kline&Kline, 1995,
p.11). The value was determined by professional business appraisers as a fundamental fair
value. Also the shares of the only two privatized companies that are already traded on the
Slovenian organized stock markets trade for much less than their value (expressed in real
terms) determined by business appraisers - Kolinska from 46% to 92% and Mercator from
22% to 34% of the appraised value from the date of their listing to May 30, 1996. The prices
of shares traded out of this markets reach levels as low as 13% and are in most cases sold for
the prices around 33% of their appraised value (expressed in real terms).
16
It is very important to note that even if "privatization" funds would be appropriate
owners and all citizens who would otherwise be inappropriate owners of privatized
companies would exchange their vouchers for shares of "privatization" funds, the essence of
the "miracle" model is achieved. The majority of citizens would still be inclined to sell the
shares, and according to research (Kline&Kline, 1995, p.11), the propensity to sell shares of
"privatization" funds is even higher than for the shares of privatized companies.
8
The essence of this "consolidation" lies in the alliance of the "miracle" model with the
interests of potential foreign and domestic strategic and portfolio investors. Companies in the
form of public corporations owned by ignorant and uninformed shareholders offer potentially
high profits for these investors who are able to buy highly undervalued shares of companies
when the supply of shares is much larger than demand.17 With the sale of undervalued shares
an important part of wealth is redistributed from original owners of vouchers to buyers of
their shares.18 But the political cleverness of the "miracle" model which prevented the model
from public criticism was in the "democracy" of the redistribution - no one is forced to sell as
everyone sells his own shares at his or her own will.
In spite of this, there were some unfavorable reactions in some countries to this first
redistribution when buyers were foreigners.19 The proponents of the model were forced into
certain restrictions for foreigners at this stage. 20 But these restrictions were just partly
effective and a stage followed, when foreigners are "begged" to buy and invest in the
companies. Also, the pressure of a newly developed domestic "capital market industry" to
17
Looking from the macroeconomic perspective, the maximum demand for the equity
stock of the privatized companies equals domestic savings plus net foreign investments. The
crucial factor concerns the level of equilibrium of demand and supply at the time of sale. By
definition the sale of the total privatized equity stock in two or three years causes a huge
excess supply which reduces the prices extensively. This macroeconomic process was
explained theoretically by Ribnikar (1996) and it was estimated for Slovenia that in a two
year sale prices would drop by about 67% (Mramor, 1994).
18
One can argue, that selling at a substantial discount is a normal practice also when
governments are privatizing companies in developed countries, but not on a average 60-70%
discount. Capital gains from privatization of some people would be too big to avoid public
outcry and the government would probably not survive. In a much smaller case of 37%
underpricing in British Railways leasing unit privatization we can reed: "The news sparkled a
political firestorm. Labor party officials and some taxpayers charge that the conservative
government deliberately underpriced British Rail assets to speed up its sale and are
demanding an investigation into the privatization process." (Flynn, 1996, p. 48).
19
For example Szabo (1993, p.8) describes the opposition to extensive foreign
(mainly direct) investment in Hungary, as a ("sale") method of privatization: "Concerning
foreign capital, ..., others speak of selling out of markets and selling the national property at a
low price and step up with a charge of 'betraying the nation'. ... (They) would introduce
restrictions against foreigners."
20
In Slovenia, the privatization law prohibits selling of certain classes of
"privatization" shares to foreigners for a certain period of time.
9
free foreign portfolio investments in order to increase demand for shares, liquidity and
turnover on the capital market reduced the restrictions in some countries.
Stage III - Regulation issues
It is quite surprising how little emphasis was at first put on the issues of regulation. It was a
widespread naive belief, that market forces would solve all the problems. One would think
that this was a consequence of incomplete understanding of market economics by former
socialist countries but neglect of regulation issues was shared with prominent foreign
advisors. Only when abuses began seriously eroding the general trust in the "reform", was it
recognized, that a market economy is in many respects much more regulated than a command
economy. This is especially the case in the area of finance, where countries in transition faced
the same kind of abuses as did market economies before the extensive regulation became
more or less effective. To protect the "achievements" of the first two stages, impressively
huge sums of foreign technical support began flowing toward regulation to develop laws (on
securities markets, banks, investment funds, companies, dematerialization, etc.), institutions
(central bank, security and exchange commission, ministry of finance, etc.) and policies and
procedures. As usual, at the beginning technical support was mainly used to finance writing
legislation and consulting on institutions by foreign consulting companies. Only slowly it
became clear that law is not enough and that education, understanding and experience of
regulators are prerequisites for efficient regulation. Foreign technical support followed these
findings rather slowly.
Considering the short period of time, a lot was done in this area in countries in transition
especially regarding the regulatory infrastructure (legislation and institutions).21 In this way,
the proponents of the "miracle" model were quite efficient insuring that the model will in its
final stage produce the desired results of maintaining a certain level of public trust in the
model and insuring that the profits gained are safe in the hands of their owners.
21
It will take some time though, before the understanding and analytical skills of
regulators and the jurisdictional systems will be adequate to reduce widespread abuses and
10
ensure more or less continuous public trust.
11
At the same time, the issue of overregulation of financial sector was constantly raised by the
proponents of the model. It is quite normal in developed countries to introduce different
measures that would ensure stability of the capital market after privatization - bonuses for
not selling within certain period of time (i.e. Great Britain, Spain, France) , taxes of different
kind to stimulate long term shareholding (i.e. Austria), Italian government promised to
"insure" shareholders against any collapse in the share price in the first year of trading, etc.
However, the proponents of a "miracle" model and politicians proclaim this kind of
regulation or policies as overregulation and limitations for the market forces. Their proposals
and actions are very much concerned with preventing regulations and policies to stabilize the
financial markets.22 From the perspective of the "miracle" model stabilization of financial
markets would prolong the process of "consolidation" which would increase total demand for
shares and, therefore, reduce the scope of redistribution. To be consistent with the primary
goal, they are proposing and introducing measures, that speed up the process of
"concentration" of ownership like removing the capital gain tax for original shareholders,
when they sell "privatization" shares (Slovenia), removing all obstacles for foreign portfolio
investments, etc..
Stage IV - Macroeconomic backlash and the second redistribution
As it is well known from the countries that experienced high inflation, without real sector
growth the redistribution only hides the problems for a while. When they become apparent
they are much worse than they would have been without redistribution. The financial sector
can not be (miss)used for the extensive and rapid redistribution of wealth without (negative)
consequences for the real sector. This is also true for the quick implementation of the
"miracle" model, whose main logic is redistribution and not creation of value, with an
additional interesting result - negative consequences enable further redistribution of wealth.
An excellent example is an article of Jašovi_ & Simoneti (1995), in which the
authors argue that too extensive legal requirements concerning takeovers enabling the
government to control foreign investment in recently privatized companies would not be in
the interest of small shareholders and national economy.
22
12
The primary macroeconomic repercussions of the implementation of the model are on
consumption and savings. It is a well known fact that propensity to consume is growing in
economies in transition, and it is usually explained by expectations of a much "brighter"
future following the change of the political social and economic system. It can also be
explained by a sharp decrease of (mainly forced) savings by companies which increased
salaries and was coupled with a sharp increase in quality of supply of goods and removal of
consumption restrictions faced by people of this countries.23
Concerning the "miracle" model, the consumption increase is caused also by the increase in
income of households through selling "privatization" shares (of companies and investment
funds). As was explained, households are anxious to sell. Further more, the proceeds from the
sale of shares are used mainly for consumption. In the former "command" economies the
household sector savings were low (paired by high business sector savings), due to relatively
even distribution of national income and a very generous social security system, which caused
most household income to be used for consumption. This pattern still persists, partly because
social security systems have not changed yet considerably and partly due to slow changes in
people's behavior. It is also usually the case that households that do not intend to sell the
"privatization" shares consume more. This is partly because they have received part of the
former state (or social) capital and they feel personally wealthier (the wealth effect) and partly
because of their new income stream in the form of dividends.
The result is, that domestic savings are decreasing. While domestic buyers of "privatization"
shares are using their savings or savings of others (through the financial system) to buy the
23
There are also other explanations, for example: "According to official data, Russian
private consumption rose in 1993. The rise may at first sight appear inconsistent with the
recorded production decline which might have been expected to entail a sharp drop in
personal incomes. However, personal incomes have been buoyed by a terms-of-trade game
gain and by a fall in income transfers out of Russia." (Transition Report, 1994, p.146)
However, this explanation is not fully consistent with a 15% decline in 1993 real GDP in
Russia, and it is hard to apply such an explanation to other countries in transition at the same
stage of transition process that have had similar trends. For example, in the Czech Republic,
which is usually regarded as the most advanced in implementing the model, GDP in
constant prices in 1992 decreased by 6.4%, and private consumption increased in constant
prices by 20.4%. Private consumption increased more than GDP also in 1993, 1994 and 1995
13
shares, the sellers use the proceeds mainly for consumption. As an important part of goods is
imported increase in consumption leads to trade account deterioration.
Low levered privatized companies are also involved along with financial investors in this
process of buying their own "privatization" shares on the secondary market. Because buyers
of privatization shares are scarce, the original voucher owners of companies and privatization
funds press low levered companies into stock repurchases, resulting in increased leverage.
(Transition Report Update, 1996, p. 30).
14
Domestic savings are further reduced because of the specific dividend policies of privatized
companies caused by this type of privatization. As we explained above, the original voucher
owners of companies and investment funds are low income "clients" with high concern for
income and low concern for capital gains. Therefore, they require inappropriately high
dividends relative to investment needs and opportunities. Also, in the fight for corporate
control, managers and workers use all sorts of "creative accounting" techniques to direct to
"their hands" as much income of the company as possible, which is then used to buy
undervalued shares of the company.24 Accounting standards and the auditing profession are
still in their infant phase of development in economies in transition which allows companies
more "freedom" in their accounting policies.
Concerning savings, we can conclude that the companies have less internally generated
capital due to higher than normal requirements for dividends, higher (accounting) costs
associated with the attempts of workers and managers to take over the company and higher
leverage. As we have explained above, externally available domestic capital for the
companies is also very scarce.
24
For the analysis of this process in Slovenia, see Mramor (1996).
15
Low domestic savings cannot satisfy the needs for investment. There was quite some excess
productive capacity available after the economic collapse of the domestic and international
markets of former "command" economies, unfortunately, only some of it was appropriate
for use in the more competitive foreign and (opened) domestic markets. Now it is more or
less used up, and high investment is needed. 25 Low domestic savings combined with an
increased need for investment results in high costs of capital and leads the companies in the
direction of undercapitalization and deterioration.26
In addition, low domestic savings and high investment needs are occurring more or less
simultaneously in all transition economies, which increases enormously the demand for
foreign capital. Combining the reduced prices and increased required rate of return on capital
in the stage II with excess demand for domestic and foreign capital brings us to the second
redistribution of the "miracle" model. Foreign and (scarce) domestic investors are able
(actually begged) to buy assets at deeply depressed prices with prospects for high excess
returns. These are excess returns form the second wave of redistribution of wealth in
economies in transition.
25
See Mramor (1995) for the forecasts of domestic savings and investment in
Slovenia.
26
In Russia, where this effect is already present in many companies "... 30% of
company directors say that they are prepared to give up control over their enterprises in return
for investment." (Vasiliev, 1996, p. 10). And further in Czech Republic: "Large foreign
investors are moving in, buying up struggling small breweries and acquiring a portfolio of
beloved brands to export. A cottage industry that is the source of national pride is , Czech
beer is fast becoming the domain of international corporate giants."(Drake, 1996, p 23)
16
Economic efficiency can not be achieved in these completely unstable circumstances of
redistribution. This is always the case, when (re)distribution of wealth, and not its formation,
is the focus of the society. Not before the redistribution is completed can the question of
economic efficiency be addressed. This fact is used by the proponents of the model as an
argument to finish the "consolidation" of ownership as quickly as possible in order to assure
stability and efficiency of the economy. But this is again one of the crucial features of this
model, that it is more "successful" (in redistribution) the faster the process is. On the basis of
this model the speed of process of transition is the most important factor of redistribution. For
the proponents of this model, the most favorable outcome of the process would be achieved if
all countries in transition would use the voucher model and simultaneously privatize the state
(or social) sector as quickly as possible. Then, most of the capital stock of these countries
would be in the hands of foreigners and scarce domestic investors for a symbolic price.27 It is
therefore no surprise that the pressure for speed on countries in transition is very strong from
governments of developed countries, international organizations, foreign creditors, rating
agencies etc.28
From the political perspective, the "miracle" model redirects (of course for a limited period of
time) domestic savings into consumption and helps to prolong the public enthusiasm and
support for fast mass privatization. At the same time it enables foreign capital to enter on
extremely favorable conditions at the moment when sustained economic growth is impossible
without it and even the reluctant politicians are forced to give favorable treatment to it.
Usually they are using arguments like, "there is no closed developed market economy" or:
"There were also a lot of attacks, demagogic and cheap populist discussions of the
sale of Slovenia and similar. However, it is very positive that a convincing majority
supported the European direction. It is simply an answer to the question, can a small
Slovenia exist outside European Union or not." (Drnovšek, 1996, p.35)
27
"The actual speed of the privatization is limited only by technical constraints,
otherwise the optimal speed is: the faster the better." (T_iska&Jelinek-Francis, 1991, p.119).
28
"Transition indicators" for the scoring systems of the efficiency of transition process
in each of the countries are usually based on the speed of privatization and level of
liberalization primarily to foreign trade and investment. For example, see Transition Report
(1995, pp.11-13).
17
The consequence of this is, that most of the existing restrictions on foreign portfolio
investment are being removed.29
Stage V - Inefficient capital markets (third redistribution)
This stage is not formally a part of the "miracle" model, but it is its inevitable consequence,
because (underdeveloped) capital market is required by this model. Underpriced shares attract
not only strategic investors and institutional investors with a long term commitment to the
investment, but also a significant amount of short-term speculative capital. Therefore, the
consolidation process of ownership is not finished yet for the companies or for the
"privatization" funds.
As is well known, the goal of speculative capital is to earn as high profit as possible in a short
period of time, exploiting as many existing inefficiencies in the market as possible. And due
to the early stage of development of the capital markets in countries in transition and many
peculiar effects of the transition process, inefficiencies are abundant. Thin markets with a big
number of small uninformed shareholders, underdeveloped regulatory systems and
supervision, allow speculators not only to speculate but also to manipulate the market.
Already in 1991 Jedrzejczak (p.139) forecasted for Poland:
"Thirdly, there is a lack of knowledge about the principles according to which the
market functions. The experience of other countries has shown us, that this might
mean that the people who gain this knowledge first will be able to manipulate the
market relatively easily and make significant profits. The experience of recent years in
Poland shows, that manipulation at the company level permitted the establishment of
spectacular fortunes. At present we can expect attempts to transfer this "capital
innovationing" to the level of the stock market."
His explanation of the level of understanding of capital markets and his forecast of the
29
Finance is the vehicle for the implementation of this redistribution, and the authors
of the model should get a desired Nobel prize for developing a model of revolution in which
the majority of people who are expropriated of (their) wealth are not only unaware that this
has happened to them but, quite the opposite, have a feeling that they have gained from it.
18
consequences both proved to be very accurate for all the countries in transition.
Manipulative foreign portfolio investments are usually large enough to move low initial
prices of certain shares in the upward direction for a period long enough to persuade naive
and ignorant domestic public to begin investing their bank savings (expected return is high
enough to offset risk aversion). The increased demand is smoothly guided into a slow shift
from foreign manipulators to domestic investors in such a way that volume constantly
increases, causing steadily increasing prices and attracting more and more domestic investors.
If it is done "properly", the "bull" market spreads to other shares.30 When the process starts,
all that speculators have to do is to wait and determine the moment when available domestic
savings will be exhausted. Before this happens, they sell the shares and "realize" the profits
and watch how the market collapses. They usually say that their market timing was
appropriate. Then they wait for "the market to recover" or in other words for domestic
investors to be forget the bad experience and be willing to invest again on expectations of
extraordinary returns. 31 Of course, the cycles become less and less distinct, as domestic
investors learn from their previous (bad) experiences and thinner than without these
developments.
The same result is achieved when domestic manipulators engage in these activities. Because
they lack sufficient funds they can not use high volumes to "move" the prices. Instead,
knowing well the flaws in the regulatory system and supervision, they use different kinds of
price manipulations to "move" the market prices in the desired direction.
Recognizing these possibilities for a transfer of wealth, foreign countries are pressing
30
Rises in stock market indexes of several hundred percents (around 600% in Poland)
in a period of less than a year were quite usual in countries in transition even before the
"miracle" model was fully implemented.
31
It seems that this year the process of manipulative foreign portfolio investments
started again. After a period of more or less "bear" market, prices are growing quickly again.
For example, in the period January - April stock market indexes increased by 88% at
Budapest Stock Exchange, 33% at Prague Stock Exchange and 65% at Warsaw Stock
Exchange (G.B., 1996, p.9).
19
countries in transition to totally liberalize foreign portfolio investments.32 Also, charges of
overregulation of the stock market are constantly made by the most active actors on these
markets.
It is of course self evident, that such extreme movements on the secondary capital market,
accompanying transfers of wealth are not the normal stage of development of a deeper and
wider market with higher fluctuations than mature markets. Further reduced domestic savings
as its consequence, are detrimental to the entire financial and real sectors of economies in
transition.
Conclusion.
32
For this purpose they also use international institutions, like the World Trade
Organization, the World Bank, and European Union (EU). The author was negotiating the
capital market articles of the Association Agreement of Republic of Slovenia with EU and the
question of allowed restrictions on foreign portfolio investments in Slovenia was one of the
toughest to negotiate. Also business press from developed countries criticizes restrictions on
portfolio investments in countries in transition even if they are implemented by the central
bank fearing inflation effects (critique of Slovenia's policy can be found in Business Central
Europe, September 1996).
20
There is little doubt after the negative experience with "command" economies, that private
ownership is a necessary condition for a long-term economic efficiency of the economy.
Privatization is in this context sooner or later inevitable, therefore, the main question was,
how to privatize to increase economic efficiency as soon as possible. Many models were
offered and a few were applied, among them most widely "voucher" privatization model "miracle" model. It is claimed in this paper, that the primary goal of "miracle" model, when
applied, was not economic efficiency, but it was chosen because of political attractiveness of
its redistribution effects. Namely, from the economic perspective, the "miracle" model is not a
model of value creation as capital does not flow into investment in real assets but a model of
(re)distribution of value to a few domestic and mainly foreign investors.33 Because of that, its
implementation prolongs the time period needed to achieve the most efficient corporate
governance, and stimulative and stable macroeconomic environment, although it is usually
claimed the opposite. The problem is, that the faster is privatization using this model, the
larger are side effects on macroeconomic stability and growth of GDP and longer it takes to
achieve certain level of economic development. But the fact is, that a great majority of
countries in transition use this model of privatization and to minimize its negative economic
effects a kind of "fine tuning" policy measures are necessary. On one hand, the change of
initial privatization stage nonoptimal ownership structure is needed,34 as well as the changes
in the organizational form of enterprises as it is not economic for all privatized companies to
be public corporations. On the other hand, policy measures should ensure such a speed of this
changes, that a certain level of macroeconomic stability (monetary stability, stability on
capital markets, level of generated savings etc.) would be maintained. Optimal combination
of stability and speed is what can in present circumstances produce the best economic results.
Unfortunately, present optimal solution from the economic perspective allows much less
redistribution of wealth, and this is the main reason why speed is preferred so far in spite of
already producing suboptimal economic results.
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33
The model of transition based on the "sale" method of privatization would achieve
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34
Additional nonoptimality in some countries is majority of shares in the ownership of
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23