1300;? 4~i, ~q104 CFS Discussion Paper Series Eastern European Experience with Small-Scale Privatization A collaborative study with The Central European University Privatization Project Cofinancing and Financial Advisory Services (CFS) The World Bank April 1994 CFS Discussion Paper Series, No. 104 Eastern European Experience with Small-Scale Privatization A collaborative study with The Central European University Privatization Project Authors: Study Directors: Roman Frydman Roman Frydman Andrzej Rapaczynski Andrzej RapaczynskiYoung John S. Earle Joel Turkewitz Advisory Committee: John Nellis With contributions from: Douglas Webb April Harding Ilham Zurayk Carla Kruger Jan Mladek Tatiana Nemeth Kumar Ranganathan Anthony Sinclair Abridged by: Shyamadas Banerji For additional copies of this publication, please contact: Cofinancing and Financial Advisory Services, Room Q-5030, (202) 473-1228. ACKNOWLEDGMENTS This paper is the result of a collaborative effort between the Central European University Privatization Project and the Private Sector Development and Privatization Group of the Cofinancing and Financial Advisory Services of the World Bank. An Advisory Committee was established to guide the work and was comprised ofstaffof the Private Sector Development Department, the Legal Department, and Europe and Central Asia Country Department II of the World Bank. We would like to thank the Government of Japan for providing substantial funding for this study, and would also like to thank Anil Sood and Ilham Zurayk of the Europe and Central Asia Region for their support in undertaking this study and for their comments on earlier drafts. The Governments of the Czech Republic, Poland, and Hungary also generously provided time, information, and support to the research teams. Steven Friedman and Karin Rebecca Schumann graciously provided organizational support for the whole project. The paper has benefited greatly from the editorial assistance provided by Emily Evershed and Antoinette Burnham. We wish to extend our thanks as well to the local teams that greatly contributed to the research effort and that were comprised of the following members of the Central European University Privatization Project: Richard Bures, Karel Cermak, Anton Marcincin, Michal Mejstrik, and Emanuel Sip in the Czech Republic; Ewa Appenheimer, Jaroslaw Gora, Wojciech Maciejewski, Piotr Makowski, Agnieszka Pecura, Krzysztof Rybinski, and Wanda Wojciechowska in Poland; and Ferenc Laczo, Erzsebet Lukacs, Monika Lukacs, Maria Mora, Gabriella Pal, Laszlo Szakadat, Isrvan Janos Toth, and Laszlo Urban in Hungary. We are also grateful to PENTOR (and especially to Eugeniusz Smilowski) and ECOMA for assistance in the preparation and carrying out of the country surveys in Poland and the Czech Republic, respectively. George Ftaya provided invaluable technical support in analyzing the results of the survey. FOREWORD This study examines the experiences of three Eastern European countries-the Czech Republic, Poland, and Hungary-in privatizing the retail, catering, and service sectors of their economies. The primary objective of the study is to analyze small-scale privatization in these countries in order to identify practical lessons and operational recommendations for decision-makers responsible for implementing small-scale privatization programs in Central and Eastern Europe and Central Asia. The study focused on the privatization of small non-manufacturing business units, defined for this purpose as business units with fewer than 50 employees in non-manufacturing service sectors, such as retail trade. The study is based on parallel investigations, which include a comparative review of various privatization processes and a survey of privatized business units in each country, and was undertaken between late November 1992 and August 1993 as a collaborative effort between the Central European University Privatization Project and the World Bank. The study is part of a larger effort by the World Bank and USAID to disseminate the lessons of the privatization experience in Eastern Europe. Other studies being undertaken cover: trade sales (World Bank), and mass privatization and corporate governance (USAID). As a central department of the World Bank, an important function of Cofinancing and Financial Advisory Services (CFS) is to act as a clearinghouse forworldwide experiences in the areas of privatization and private sector development. We are pleased to present this review of small-scale privatization in the Czech Republic, Poland, and Hungary. Inder Sud Kevin Young - Director Manager Cofinancing and Private Sector Developmentand Privatization Group Financial Advisory Services Cofinancing and Financial Advisory Services iii TABLE OF CONTENTS Acknowledgm ents ....................................................................................................................ii Foreword.................................................................................................................................iii I. M ain Findings and Policy Implications ........................................................................... 1 Objectives and Scope ........................................................................................................ Organization of the Report............................................................................................... 1 The Setting ...................................................................................................................... 1 D iversity ofApproaches .................................................................................................... 2 Results ............................................................................................................................. 4 Transfer ofAssets ............................................................................................................. 4 Ownership Rights............................................................................................................. 5 Importance of Outiders ................................................................................................... 7 M ethod of Sale ................................................................................................................. 8 New Entry ....................................................................................................................... 9 Emploent1..................................................................................................................... 10 Competitive Units ............................................................................................................ 10 Policy Implications........................................................................................................... 11 II. The Czech Republic......................................................................................................... 13 A. Introduction ............................................................................................................... 13 B. Restitution.................................................................................................................. 15 C The Small Privatization Program ............................................................................... 16 D. The Large Privatization Program ............................................................................... 19 E. Transformation of Trade Cooperatives ........................................................................ 22 Annex2.1.............................................................2.. 6.................-.....2 Annex 2.2 ........................................................................................................................ 27 Annex 2.3 ........................................................................................................................ 28 III. Poland ............................................................................................................................ 29 A. Introduction ............................................................................................................... 29 B. Changes in the Real Estate M arket in 1990................................................................. 32 C. M unicipal Government (GM INA) Privatization ........................................................ 34 D. Privatization By Housing Cooperatives ...................................................................... 38 E. Privatization of Units Owned By State Enterprises...................................................... 38 F. Restructuring and Privatization of the Polish Consumer Cooperatives.......................... 40 iv IV. H ungary ......................................................................................................................... 45 A. Introduction ................................................................................................................ 45 B. Pre-1990 Reforms........................................................................................................ 49 C Preprivatization Program ............................................................................................ 51 D . First Privatization Program ........................................................................................ 53 E. Sef -Privatization ........................................................................................................ 54 F SPA Plans for the Remaining State Units ..................................................................... 57 G. The Transformation of Hungarian Consumer Cooperatives ......................................... 57 V. Survey ...............................................................................................................................61 A. Introduction ................................................................................................................61 B. Population and Sample Selection .................................................................................61 C. Participants andAssets ................................................................................................ 63 D . The Transfer Process ................................................................................................... 64 E. Post- Transfer Behavior and Environment .................................................................... 69 F Behavioral Implications of the Transfer Contract .........................................................73 G. Behavioral Implications of the Competitiveness of the Mode of Transer .......................74 H. Behavioral Implications ofPost-privatization Ownership Structure .............................74 i -1 Chapter One Main Findings and Policy Implications Objectives and Scope term applied to the programs that transfer owner- ship of large numbers of shops, restaurants, service 1.1. This study examines the experiences of three outlets, and other small units. Small-scale, or small, Eastern European countries - the Czech Repub- privatization has been the main avenue for lic, Poland, and Hungary - in privatizing the privatizing the retail and trade sectors. However, retail, catering, and service sectors (hereafter re- since retail sector privatization can also involve ferred to as the sector) of their economies. It is still larger chains as well as cooperatives, other ap- too early for definitive conclusions to be drawn, proaches, including large-scale privatization, will since the impact on the creation of a vibrant con- also be examined where relevant. sumer sector may not yet be complete. Thus the conclusions of this study are of necessity qualified Organization of the Report and partial. Nevertheless, since these three coun- tries have been grappling with the privatization of 1.4. The present study is based on two parallel this sector since 1989, they have a rich body of investigations: (1) a detailed examination of the experience upon which others may draw. process followed by each of the three countries in 1.2. The objective of this study is to derive privatizing the sector, and (2) a uniform sample lessons that may be useful to other countries, par- survey of privatized enterprises in the three coun- ticularly those of the former Soviet Union (FSU), tries. This chapter is intended to distill and inte- that are also currently involved in privatizing their grate the broad lessons and conclusions derived retail and service sectors. It is not the objective of from this dual approach - the three country this study to assess or rank the overall approaches of studies and the survey of enterprises. To this end, the each country nor to propose one country's ap- chapter briefly summarizes the main cross-country proach as a model. The approach adopted in any findings and lessons applicable to key aspects of the particular country would require tailoring to spe- transformation process. To orient the reader fur- cific country circumstances: the level of political ther, a brief description of the approach taken in commitment, the success of macroeconomic re- each of the three countries is provided. Chapters II, forms, the legal and institutional framework, the III, and IV summarize each of the country studies, relative power of various stakeholders, and the and Chapter V discusses the survey. organizational structure and performance of the sector. Rather, the objective is to draw general The Setting lessons from both the positive and negative experi- ences of the three countries that could be applied to 1.5. Prior to the transformation, the retail, cater- a variety of programs and country conditions. ing, and service sectors of the Czech Republic, 1.3. The primary focus is on what is commonly Poland, and Hungary were dominated by large referred to as "small-scale privatization" - the state enterprises and consumer cooperatives. Both 2 Eastern European Experience with Privatization of these institutional forms were tightly controlled state-owned units, reforming the pseudo-coopera- by apex bodies: the former usually by' a ministry of rive system, and encouraging the entry of new trade and the latter by a central cooperatives asso- private entrepreneurs. However, there was great ciation that functioned under the government's diversity in the specific policies and programs used direction. Individual enterprises, usually compris- to achieve these objectives. To an important extent, ing a large number of retail units, operated in this reflected differences in the political and eco- specifically defined markets and faced little or no nomic milieus among the countries. The varying competition. Storage and input distribution net- outcomes resulting from this diversity ofapproaches works were rigidly controlled by wholesalers oper- provide interesting comparisons. These different ating in specific regions, and retailers had little approaches adopted for privatizing the retail and freedom or flexibility in supply and purchasing trade sectors cover a wide spectrum, ranging from decisions. In most cases, the real-estate premises a classic privatization process of auctioning indi- from which the shops, catering, or service establish- vidual stores (the Czech Republic) to the simple ments operated were owned or controlled by local commercialization of real estate (Poland), with a governments or housing cooperatives. The owners more gradual insider-dominated approach that was were required to rent the premises to state enter- often geared toward the privatization of whole prises for indefinite periods at modest rentals. In enterprises (Hungary). developing a privatization strategy for these enter- 1.9. In the Czech Republic, a transparent auc- prises, decision-makers faced a number of complex tion-based system was adopted as the primary track issues with regard to the future structure and effl- to privatizing the retail and trade sector. This ciency of the retail sector, as well as issues relating approach was in explicit opposition to insiders, to ownership and the preservation of employment. who were interested in maintaining control over 1.6. While the retail sectors in all three countries large supply networks and chains ofstores and who were inefficient and provided a limited supply of attempted to manipulate the process to their ad- goodsandservices to the public, thesupplysituation vantage. The public had little sympathy for the in Hungary was relatively better than that in Po- insiders'plight, and newspaperscampaignedagainst land and the Czech Republic because Hungary had insider preferences. As a result, Parliament enacted initiated reforms in the enterprise sector much a small privatization program in January 1991 that earlier. The Hungarian retail sector had benefited adopted open auctions as the method of sale, al- from laws dating back to the late 1960s and con- lowed anyone to propose any asset for sale, and tinuing through the 1980s that allowed the entry of granted no preferences to insiders. The Privatiza- small private businesses in various legal forms into tion Ministry supported the privatization of as the production and retailing sectors. Nevertheless, much property as rapidly as possible. The policy of the paucity of retail distribution outlets resulted in favoring speed over technocratic issues tended to poor customer service in all three countries: the foster rapid approval of small privatization proposals. density of retail outlets in the three countries was 1.10. A second track to privatizing this sector was about a third of that in Western economies. "reprivatizarion." Among post-communist coun- 1.7. Following the collapse of their command tries, the Czech Republic developed one of the economies, the new governments chose the trade broadest programs of restitution, which returned and services sector as one of the first targets for specific assets to their former owners - thus the privatization. In many ways, this sector was the easiest term "reprivatization." The restitution laws made toprivatize. Itwasgenerallyfelt that private ownership plain the possibility that any enterprise assets, par- of trade and services would be more efficient, that the ticularly retail units, would be vulnerable to absence of economies of scale and indivisible capital reprivatization. Thus, for insiders, it was unclear implied that relatively few corporate governance which assets would remain to provide the basis for problems would arise, and that the under-represen- corporatization. tation of trade and services in the economy as a 1.11. Enterprise remnants that survived restitu- whole implied tremendous possibilities for growth. tion and small privatization were corporatized, and included in the large privatization program. Enter- Diversity of Approaches prise managers anticipated that they could main- tain control of their companies if the predominant 1.8. The objectives adopted in all three countries method oftransfer was to be voucher privatization. comprised, in varying degrees, privatizing existing But the opportunity given to outsiders in late 1991 Eastern European Experience with Privatization 3 to submit "competing projects" against the "basic freedom to operate and restructure themselves. prolects" submitted by the insiders, and the outsid- Restrictions on private business activity in the trade ers' prompt response, drastically altered the situa- sector had been eased, although by no means elimi- cion. Furthermore, the astonishing success of nated, and the state permitted and even encouraged InvestmentPrivatizationFundsinearly 1992,which a variety of private economic entities. Legislation in total attracted 72 percent of all voucher points, on private economic activity also became more promised to create a less dispersed share ownership liberal. By the late 1980s, all segments of Hungar- structure and therefore increased the possibilities ian retail trade and services included a sizable for effective control of privatized enterprises, private component. The new arrangements signifi- through the use of vouchers. cantly changed the retail and service sector: they 1.12. In Polandthere was no separate small priva- introduced some market-driven elements into the tization program and the impact of the general sector and affected the role of the state enterprises privatization law was minimal. Instead, a series of in the provision of consumer goods and services. governmental acts not directly related to privatiza- 1.15. Thus by the end of the 1980s, when the tion released a spontaneous and largely unregulated major transformation in Eastern Europe was taking process in which the existing special interests were place, the reforms had already had a significant pitted against each other and were enlisted in the impact on the consumer sector. Hungary differed process of transformation. The key to this approach from the Czech Republic and Poland in that there was the centering of the transformation not on the were significant numbers of private establishments privatization of businesses run by the socialized in existence at that time. Although the state sector domestic sector but rather on the transfer ofthe real still dominated commercial activity, state enter- estate on which these businesses operated to the prises operated with an unparalleled degree of private sector. The essence of small privatization in freedom, and a large portion of trade activity was Poland was thus a transfer of interests in commer- controlled by semi-private individual units. As a cial premises to private parties. result, the trade sectors operated with a tolerable 1.13. The Housing Act Amendments of 1990 degree of efficiency. Finally, and significantly, the gave impetus to this approach by giving the owners managers had increased their strength and bargain- of premises unlimited freedom to terminate a lease ing power vis-a-vis the government and had be- of indefinite duration and to rent at market rates. come important stakeholders whose views and Strapped for resources, the municipal governments interests needed to be taken into account if further (gminas) quickly reclaimed large numbers of pre- reforms were to succeed. mises and leased or sold them to private parties. The 1.16. The complex status of the state sector and process was highly decentralized, and insider-nego- the increased power of the managers made it diffi- tiated arrangements predominated. In addition to cult for the government to proceed according to this approach of commercializing real estate, Po- any centralized or comprehensive design to privatize land alsospurred small privatization bybreakingup the trade and service sector. Nor was the govern- large cooperative associations through legislation ment able, as in Poland, to provide incentives to that led to the transfer of a large number of stores selected outsiders, such as municipalities and other and service units to private hands. The remaining real-estate owners. Consequently, Hungary's ap- state-owned enterprises, generally those on prop- proach to privatizing shops and restaurants has erry owned by the central government, are being been made up of a mosaic of small programs tar- privatized primarily through the "liquidation" geted at discrete segments of the trade sector. method in which the assets are sold or leased to a Transfer of individual shops to private parties was new company that has been formed especially for deemed appropriate for only a portion of the sector. this purpose. The majority of state assets involved in trade and 1.14. In Hungary the initial conditions for services have been, or are about to be, privatized in privatizing the consumer sector differed consider- ways that emphasize the transfer of many units ably from those in the Czech Republic or Poland. grouped together to form integrated commercial As a result, the process itself was very different. In entities. Hungary, enterprise reform began much earlier. 1.17. In the late 1980s, state enterprises and unit Throughout the 1980s there had been a significant managers in Hungary were encouraged to form amount of enterprise reform in the consumer sec- separate business entities from a portion of the tor. State enterprises had been given considerable assets of existing parent companies. This led to a 4 Eastern European xperience with Privatization significant increase in the number of retail and also because property relations in the sector are catering units operated by incorporated compa- often unclear and information about ownership nies. In 1990, the Preprivatization Program was can be difficult to obtain. Over 10,000 shops and adopted, which was the only program designed catering units have been privatized, primarily specifically for the transformation of the retail, through the Preprivatization Program. Over 12,000 catering, and service sectors. An important objec- individual units have remained under state owner- tive of this program was to address the abuses of ship, a much greater proportion than in Poland or uncontrolled spontaneous privatization. The the Czech Republic, partly as a result of the con- Preprivatization Program targeted the smallest units scious policy of privatizing entire enterprises. The in the sector for sale, predominantly by auction. Hungarian retail sector has also been transformed Enterprise managers had incentives to keep their by the rapid entry of a large number of private most valuable units together as a network and to operators. In addition, many enterprises under release only their least valuable units to state domain operate with significant amounts of Preprivatization. About 12,000 state-owned units independent initiative and incentives. have been identified for sale under this program, 1.21. It should be stressed, however, that the data but actual sales have been significantly fewer. By on privatization for all three countries relate only to mid-] 993, some 7,000 units had been sold or the initial transfer of premises to private owners, otherwise transferred out of the state sector. and the extent of secondary market transactions is 1.18. The government has also attempted to still unknown. Important restrictions remain on privatize entire enterprises, initially in the experi- the use of these assets, such as limited security of mental First Privatization Program, and later in the tenure, restrictions on change of line of business, larger Self-Privatization Program. While the First resale, etc., which may retard the further develop- Privatization Program has generated few sales, the ment of a vibrant retail, catering, and trade sector. Self-Privatization Program has had more success in privatizing primarily small service enterprises, sell- Transfer of Assets ing more than 70 firms. In addition, the govern- ment is attempting to sell chains of stores outside 1.22. Generally, privatization implies the sale ofa the framework of formal programs. Finally, there state-owned enterprise, usually as a going concern, has been a continuing process of cooperative re- to private owners. The experience with small priva- form. Beginning as early as the 1960s, it led to the tization in Eastern Europe has brought up an sale of a large portion of cooperative stores in the important distinction in this respect. Insofar as the years between 1988 and 1990. Since 1990, coop- retail units themselves were concerned, it quickly eratives have retained approximately the same num- became apparent that there was little value in many ber of units but have gradually shifted their mix of of them beyond the premises that could be used stores toward more multi-use establishments. productively. The furnishings and equipment were generally inadequate and in poor condition, and Results inventories were often worthless or nonexistent. Supplier contacts were of no long-term value with 1.19. Overall, the results have been impressive. In the change to private suppliers, and staff were the Czech Republic, nearly all state-owned trade usually in excess of needs and lacked adequate and service establishments had been privatized by marketing and sales skills. Thus, although the the end of 1992. In Poland, by the end of 1992 the actual approach to small privatization differed sig- great majority of all shops and other consumer nificantly among the three countries, the essence outlets were officially estimated to be in private of small privatization was the transferring of the hands. This comprised large numbers of new en- premises to private owners. trants as well as privatized units. At the end of 1992, 1.23. Poland was unique in that the transforma- small privatization in Poland was almost complete tion of retail trade, catering, and consumer services with the privatization of about 194,000 units, was explicitly centered on the real estate on which representing 82 percent of the units that were the businesses had been operated. Nonetheless, the owned in 1989. survey data indicate that in all three countries the 1.20. The situation in Hungary is much harder to transfer of premises was the core of small privatiza- quantify, in part because of mixed ownership and tion, with the other business assets playing a sec- Eastern European Experience with Privatization 5 ondary role (see Table 1.1). In fact, the less devel- 1.25. An important corollary to focusing on the oped the consumer trade sector is prior to the real-estate asset is that efforts should be made to reform, the more likely it is that the transfer of real develop asecondary real-estate market forcommer- estate will dominate the entire privatization trans- cial space in order to ensure efficiency in the action. This may be of particular importance in the allocation of this scarce resource. This is especially FSU countries, where densities of stores and inven- important where the initial allocation methodol- tory levels are very low. The focus on real estate also ogy is biased toward current workers and managers favors the breakup of inefficient large retail enter- and where non-market transfer mechanisms pre- prises in the former command economy countries dominate. No special measures to develop such and promotes the privatization of individual units. secondary markets were identified in the three 1.24. An important lesson to be gained is that countries. Clearly, it will be increasingly important much time and effort might be saved by focusing on to develop such measures to ensure that the limited transferring the key asset-real estate or business space can be put to good use. premises-rather than on privatizing going con- cerns or business activities. In addition, since com- Ownership Rights mercial real estate is a scarce economic asset, it is important that it be allocated to its most economic 1.26. While the various programs grappled with users. Encumbering the transfer of real estate with methods of transferring enterprises and especially other assets and liabilities is clearly not the most premises, the actual rights conveyed were highly efficient way to achieve this transfer. The Polish restricted. Ownership rights to most of the pre- approach, that of directly freeing up real estate, was mises on which the privatized establishments oper- a very effective means of achieving this, and its ated were not conveyed; rather, only rights to leases feasibility in other country contexts merits consid- were allowed. eration, even if it is parallel with a conventional 1.27. The survey data confirm that the premises enterprise approach. Post-liquidation sale of assets, themselves are most often not privatized in the especially the real-estate asset, is another alternative strict sense of the word. Since, in the three coun- which allows the focus to fall squarely on this key tries, 75 percent of the privatized units lease the asset. Where for political reasons the sale of going premises, the legal title to these premises is not concerns is unavoidable, the preprivatization valu- conveyed into private hands. Only 12 percent of ation and sale should focus on this asset. There is the premises in the sector are owned by private little to be gained by more in-depth valuation of the individuals or institutions (other than coopera- business as a going concern. tives). Table 1.1: Parts of the Business Included in the Transfer' % of Units for which a Given Part of the Business Was Transferred Part of the Business Czech Republic Poland Hungary Premises 100 100 100 Equipment 35 40 37 Land 20 15 11 Building 28 31 35 I Transfer means rental or purchase. Source: "Survey of the Joint Study of the Central European University (CEU) and the World Bank" (hereinafter referred to as Survey). 6 Eastern European Experience with Privatization 1.28. In the Czech Republic, of the approxi- names, existing contracts, and obligations of the mately 23,000 trade and service establishments business. Sales, however, did not include inventories. included in the small privatization program, only 1.29. Moreover, the lease terms were frequently about 28 percent were or are to be sold with short. Hungarywas the onlycountrysurveyed with premises (Figure 1.1). For the remaining 72 per- a high percentage of leases with terms of five years cent, the auction winner purchases equipment and or more (88 percent). In Poland, a high proportion inventories and receives only the right to rent the of leases have terms of two years or less (see Figure premises for a fixed term. In Hungary's 1.2). The lack of a functioning real-estate market Preprivatization Program, which was specifically combined with short leases raises the obvious un- designed for the transformation of the retail trade, certainties of being able to stay in business after the catering, and service sector of the economy, typi- lease terminates. The survey therefore examined cally, the parent company did not have formal title the relationship of lease tenure to post-privatiza- to the premises on which its shops operated. De tion behavior (as measured by investment in re- facto property rights belonged to local govern- modeling). The findings on this were clear. ments, to which enterprises had been paying rent at 1.30. Lease duration is one of the key driving favorable terms. Thus, over 70 percent of the sales forces of post-privatization investment. Units with did not include premises; rather, they involved the lease terms longer than five years had more than purchase of the right to rent the premises for a double the investment rate of those with leases period often years. Units were sold as going con- shorter than five years. This is further confirmed cerns, and thus included the equipment, brand when contract risk is examined. An option to Figure 1.1 Transfer of Premises: Lease versus Purchase (Percentage) 90 70 W Purchase 50- 40 O Rent 30 20 Czech Poland Hungary Source: Survey. Republic Figure 1.2: Duration of Rental Contracts for Premises (Percentage) 90 - - 80 - - 70 -- I-- Czech Republic sO Poland 40 * Hungary 30 20 1 ' Source: Survey. 0 2 years 3-4 Years 25 years Lease Term Eastern European Experience with Privatization 7 purchase raises the mean level of investment in com- should be granted with an option to renew. The parison with rental with no option (see Figure 1.3). renewal process should be transparent and clearly 1.31. A substantial proportion of the transfer con- defined at the outset to reduce the degree of uncer- tracts that were examined have restrictions on rainty for potential bidders. Other restrictions on changes in line of business or on subletting and resale, line of business, and employment should be resale. Restrictions on subletting and resale, for avoided as much as possible. example, severely impede the operation of second ary markets and therefore hamper improvements Importance of Outsiders in the original allocation. According to the survey, the time frame ofthese restrictions is approximately 1.33. An important finding of the study is the equal to the average length of the rental contracts. significant role of outsiders in post-privatization Similarly, imposing restrictions on changing the investment. The survey measured post-privatiza- line of business can significantly restrict new own- tion behavior by the level of remodeling investment ers from responding to market forces in a cost- in the enterprise after privatization. While this is effective manner. less than a perfect indicator, it is one of the few 1.32. For the rapid development of an efficient indicators subject to unambiguous measurement market-oriented retail and service sector, there ap- and is reasonable in view of the widespread dilapi- pear to be significant benefits in conveying the full dated condition of shop premises and the conse- title of the real estate with as few restrictions as quent need for new investment. The survey data possible. In cases where leases are unavoidable (e.g., clearly show that outsiders are likely to invest in a multiple unit building in the absence of condo- significantly more than insiders in the business after minium laws), a duration of at least five years privatization. As can be inkrred from Figure 1.4, this Figure 1.3: Effects of Contract Risk on Post-privatization Investment' ($ Thousands) 6- 5- Outright Purchase Rental Rental with Option to Pooled data of all three countries. Purchase Source: Survey. Figure 1.4: Post-Privatization Investment: Outsiders versus Insiders (Pooled data) ,.00 $4000 4.943 s3000 3,862 8 Fowe Oule O Fomer fnar $2,000 2,683 2,632 $1, 000 Sole Oner or Co-Owner Soie Owner N denote7 Np34i NS N denotes sample size. Source: Survey. 8 Eastern European Experience with Privatizaion result is not due solely to the presence of outsider of ownership rights used in small privatization in co-owners presumably brought in to improve the the Czech Republic has been public auction. In financial position of the business, since single out- Poland the vast majority of the units have been sider owners also invest significantly more than allocated on the basis of closed procedures and at single insider owners. prices that most often have not reflected their 1.34. This finding is not surprising, since outsid- market value. Hungary used both auctions and ers have more resources than insider employees in negotiated sales extensively. The distribution of what is a traditionally low-paying sector. A simple methods used, based on the survey of privatized multivariate regression model supports the conclu- enterprises in the three countries, is presented in sion that the effect of outsider ownership on invest- Figure 1.5. ment following privatization is dominant. The 1.36. The appropriateness of the procedures used implication of this finding for the method of sale is in transferring ownership rights is a subject of discussed below. considerable debate in small privatization. The fundamental question that can be raised is: Do the Method of Sale potential benefits ofopen procedures (auctions and open tenders) - efficiency, equity, and transpar- 1.35. The three countries used a broad range of ency - outweigh the potential advantages of in- sales methods. The exclusive method of allocation sider support inherent in closed procedures? This Figure 1.5: Mode of Transfer of Premises Czech Republic Directly Negotiated Rental (2%) Direct Sale (1%) Poland P n Direct Sale (11.4%) Auction (97%) - Auction (10.2%) Directly Negotiated Rental (78.4%) Hungary Direct Sale (9.6%) Directly Negotiated Rental (45.8%) Auction (44.6%) Source: Survey. Eastern European Evperience with Privatization 9 study does not attempt to give a definitive answer of outsiders; this is firther addressed immediately to this complex question. However, the study and below. The survey results also underscore the need particularly the survey results underscore the potential for the rapid development of secondary real-estate efficiency benefits associated with open procedures. markets, which can allow outsiders to bid for 1.37. With regard to method of sale, the survey business premises that insiders (or others) may be results indicate that investment (post-privatiza- putting to poor use. tion) in units transferred through open procedures (auctions and open tenders) was significantly higher New Entry (46 percent) than in units transferred through closed procedures (negotiated sales and closed ten- 1.41. Analysis of the growth of new private busi- ders). This result in turn appears to be related to one nesses was outside the scope of the study. However, key factor: open procedures are much more likely it is evident from the findings that new entry is to result in outsiders taking over the business. critical to the development of an efficient market- 1.38. Thus, there are clearly benefits in involving oriented trade and service sector. This is particu- outsiders in the original privatization process. This larly important in cases in which there has been an means using open sale methods wherever possible. overall domination of ownership of the privatized In addition, priority should be given to other entities by insiders. measures that attract outsider participation, such as 1.42. New businesses have emerged in all three wide dissemination and advertisement of sales. countries, but Poland and Hungary in particular Open procedures also provide an element of trans- have experienced a rapid growth. In Poland, for parency and thus there is less likelihood of public example, despite a rapid and comprehensive pro- criticisms of abuses, which can slow or even derail gram that privatized 82 percent of consumer out- privatization programs, as, for example, was en- lets by 1992, the number of new private outlets was countered in the early reforms in Hungary. more than twice the number of privatized units. 1.39. Open procedures and other efforts to bring The growthin new businesses, however, was largely in outsiders are likely to encounter resistance from driven by the emergence of very small units operat- entrenched insiders, and governments will need to ing from own garages, homes, trucks, and roadside give special attention to addressing the interests of kiosks. In Poland, these types of businesses ac- existing stakeholders who can slow the process. The counted for two-thirds of the growth of new busi- appropriate balance can be struck only within nesses, and the new private sector's share ofturnover specific country contexts depending on the array is only 25 percent of the total. Although they are and strength of various stakeholders. In general, less numerous than the rest of the new private however, in view of the benefits outsiders can bring businesses, the units formerly owned by the social- to the transformation process, giving insiders a ized sector still constitute by far the most important preference (discount) in bidding would appear segment of the domestic consumer trade sector, preferable to using procedures that exclude outsid- dominating from the point of view of their size and ers altogether. location, and their affiliation with wholesale estab- 1.40. Finally, the benefits of bringing in outsiders lishments. also suggest that increased attention be given to 1.43. Even so, the growth of new entrants is new entrants, who constitute a large potential pool striking (see Table 1.2), and despite the small size Table 1.2: Poland: Privatization versus New Firms' (Thousands) From 1989 through 1992 Privatized Outlets Net New Private Outlets Retail Outlets 145 501 (Retail Stores) (115)2 (202) Catering Outlets 15 22 Service Outlets 34 46 Total 14 476 1 Includes new outlets opened and closed on premises not originally part of the socialized domestic trade network. 2 Includes ca. 46,000 cooperative and other stores that have been reclassified as "private." 10 Eastern European Experience with Privatization and often transitory nature of these outlets (the restructuring. Given the relatively flat compensa- failure rate is at least 20 to 30 percent per year), the tion curve characteristic of the old system, the proliferation of small private outlets played a very change is likely to result in a significant modifica- important role in creating a genuinely competitive tion of managerial incentives. environment in some product and market seg- 1.48. There is strong evidence in the survey that ments. an overall increase in employment can be achieved 1.44. This growth in the number of stores has in by the privatization of retail and services sectors. fact brought the Polish shop density levels in line Such an increase in sector employment signifi- with those of the Western economies, although the cantly reduces the social pressures of dislocation average store size is substantially lower. The density owing to privatization. This suggests that there are of stores in Poland in 1992 was about 9 per 1,000 tangible benefits to begained from directing efforts inhabitants, while Austria, France, and the United to stimulate the growth of new businesses rather States had an average density of 7, 10, and 6 stores than debating over issues relating to worker re- per 1,000 inhabitants, respectively. trenchment. 1.45. The most critical barrier to new entry is lack of access to real estate - that is, to both the Competitive Units ownership and rental of commercial space. Only if this barrier is addressed can a truly competitive 1.49. There is a clear bias on the part of the environment in all product and market segments of enterprise managers and the ministries of trade in the retail and service sector emerge. This suggests many post-command economy countries to pro- that, concurrent with formal privatization, equal tect the structure of the large trade enterprises. In importance should be given to the releasing of real Hungary, the law provided ample opportunity and estate to new businesses. This could be carried out legal basis for enterprises to argue that their units as part of the formal privatization program by, for comprised a chain of stores, and should thus be instance, making arrangements for the subdivision excluded from the Preprivatization Program. It also of premises occupied by state enterprises that are permitted the enterprise managers to retain their being privatized. Alternatively, or in addition, it most valuable units as a network of shops and to could be accomplished by focusing on making release only their least valuable units to privatiza- available other real estate owned by the state which tion. is suitable for commercial use. In view of the results 1.50. The most common line of argument taken of the study, special pilot efforts are being mounted by the Czech insiders in favor of inclusion of their in Russia, Ukraine, and Kazakhstan to pursue enterprises in large privatization was that a certain options to increase access to commercial space for unit or units made an essential contribution to the new units. operation of the entire enterprise, without which the entire network would lose viability. In addition, Employment the Ministry of Trade officials argued that the sale of individual units through small privatization auc- 1.46. As the number of outlets in all three coun- tions would destroy economies of scale in chains of tries grew rapidly in the wake of the reforms, the shops and vertically integrated networks. consumer sector represents one of the few dynamic 1.51. Although some of these arguments may be areas of growth. Total employment in the Polish valid, on balance there are significant advantages in trade sector grew by 6 percent between 1989 and dissolving the chains and associations and selling 1991. The increase in employment in this sector off individual units. The "creation" of smaller should be considered in light of the overall rise in individual units not only improves the density of unemployment, which reached 12 percent of the independent retail and services entities but also labor force during the same period. provides a way of empowering a new class of 1.47. The average employment per unit in the entrepreneurs. Protection of large enterprises, on sector is growing in both Hungary and the Czech the other hand, can lead to further concentration of Republic, but in Poland the number of both mana- the sector if the larger enterprises start acquiring the gerial and non-managerial employees is unchanged. smaller ones. This, coupled with the fact that the The ratio of managerial to non-managerial com- existing large enterprises most often have a supply pensation increased in all three countries, which chain which is vertically integrated, can lead to the indicates a positive evidence of post-privatization preservation of the status quo and can move the Eastern European Erperience with Privatization 11 sector away from the objective of creating an effi- Wherever possible, open sale procedures cient market for consumer goods and services. should be employed; this, by definition, allows outsiders to participate. Policy Implications CPriority should be given to announce- 1.52. While the policy conclusions of this study ments in the media of privatizations of must be qualified by the small sample size and the shops and restaurants; this significantly ongoing nature of the process, the study does enhances the participation of outsiders. nevertheless raise a number of policy implications 2 Small privatization should be refocused on for other countries to consider in formulating and the increased availability of real estate, executing small-scale privatization programs. A combined with an overall increase in the "short list" of such policy implications could be the number of retail and service units. This following: could be further facilitated by encouraging * Small privatization is, above all, related to the present landlords and tenants to make transfer of control (and not necessarily own- more commercial space available for new ership) of real estate from the state to private businesses. parties. Thus, policies should concentrate on The formation of secondary markets for making premises available to private busi- privatized businesses should be fostered. nesses, and should place less emphasis on In particular, restrictions on secondary transferring movable assets and business ac- transfers of privatized units should be tivities. avoided. * Sale of premises should probably be favored over leasing, since the former provides greater sigriicaton o the re orm have security of tenure and encourages investmentsinfctefcsonheromofhew l- s i sale sector ifappropriate steps are taken by the in the privatized units. government. In particular, increasing the avail- * Leases should be of long duration, preferably ability of the means of transport (above all, over five years, and, if possible, should con- trucks) to the private sector may have a very tain options to purchase or renew. significant effect on restructuring the supply * Where only the right to lease is transferred, system. transparent and certain procedures for setting * Price stability and other macroeconomic fac- rents and lease terms should be established tors are extremely important for small busi- prior to transfer. nesses, and their absence is cited by most * Post-salerestrictionsonemploymentandline respondents as a significant obstacle to the of activity should be avoided or minimized. development of these businesses. * Facilitating the entry ofoutsiders is probably the * Breaking up large retail chains and selling off most important element in fostering the restruc- individual units is likely to enhance competi- turing ofbusinesses in the wake ofprivatization. tion and to speed up the transformation This can be done by a variety of measures: process. S Chapter Two The Czech Republic A. Introduction etc., and service units of municipalities.' Table 2.1 provides a breakdown of the different types of 2.1. This section analyzes the experience involv- establishments in the sector including the distribu- ing the privatization of the trade and service sector tion of ownership between the state and the coop- in the Czech Republic. Some 68,000 state-owned eratives. and cooperative trade and service establishments 2.2. For state-owned establishments, three dif- existed in the Czech Republic at the end of 1989. ferent tracks were adopted for the privatization of These comprised about 44,000 retail establish- assets in this sector. Estimates of the number of ments, 19,000 catering units, and 5,000 hotels, establishments in each of these tracks are shown in Table 2.1: Czech Republic: Numbers of Trade and Service Establishments as of December 31,1989 State Coops Total Retail Trade 26,905 16,876 43,781 Of which: Food Stores 10,580 4,290 14,870 Mixed Stores 400 8,029 8,429 Non-Food Stores 12,220 2,525 14,745 Department Stores 53 762 815 Kiosks 3,216 307 3,523 Others 436 963 1,399 Restaurants and Pubs 10,105 9,374 19,479 Hotels, Motels, and Camps .. .. 2,863 Of which: Hotels and Motels .. 860 Pensions .. 1,353 Camps .. 650 Service Units of Municipalities 2,088 .. 2,088 Total 39,038' 26,250 68,211' 1 1 This figure and the total for cooperatives do not include hotels, motels, pensions, and camps, since the available data allow no breakdown of this category by ownership. I Unlike the separate totals for state and cooperatives, this total includes hotels, motels, pensions, and camps. Sources: 'Ukazatele v maloobchode," ECOMA Praha, mimeo, 1993; Statistical Yearbook of CSFR 1990, SNTL-ALFA, Praha 1990, pages 515, 517, and 534. 14 Eastern European Experience with Privatization Table 2.2. The most important was the "small 2.4. The division of state assets among the vari- privatization program" (SPP), a program of com- ous divestiture methods is the outcome ofcompet- petitive auctions of individual establishments. The ing claims put forward by a variety of interest small privatization program also includes some groups beginning in 1990. First, popular antipathy assets that cannot be strictly classified as part of toward the former regime led to a movement to trade and services. The second track was compensate Czechoslovak citizens or their descen- "reprivatization," the restitution of expropriated dants who had been victims of nationalization and property to former owners, which has also been expropriation through the restitution of property. quite important quantitatively. The third track was Because reprivatization had legal precedence over the "large privatization" program, which applies the other methods, the difficulties in clarifying voucher, direct sale, and other methods to privatize ownership rights, which had often become muddled generally larger entities. Other state-owned assets over time, affected privatization throughout the in trade, largely wholesale enterprises and the re- sector. Second, the sector "insiders," including maining shells offormer trade enterprises, are being Ministry of Trade officials and enterprise manag- liquidated. The future of some of the state-owned ers, favored gradual decentralization and privatiza- assets, particularly in wholesale distribution, is not tion of the existing structures, with little yet decided, but they are probably also destined for reorganization of trade enterprises. They proposed either the large privatization program or liquidation.2 leasing arrangements for some establishments and 2.3. Consumer cooperatives, which made up a the reorganization of the rest into new companies significant proportion of the sector before 1990, along the lines of the former district divisions. have gradually been divesting control over their These proposals could be regarded either as at- assets, while the remaining cooperative establish- tempts by trade officials and enterprise insiders to ments are experiencing a partial "transformation" maintain control of their valuable empires, or as of their governance and decision-making struc- "technocratic" arguments, based on the experience tures. Of the approximately 26,250 cooperatively and knowledge of "experts" and "specialists," for held establishments in trade and catering in 1989, efficient privatization of assets. Third, reformers plus some hotels and motels, about 3,500 have who had just come to power, for example in the been reprivatized, 4,000 have been leased, and Ministry of Privatization, supported rapid privati- about 12,000 have either been sold or lost to zation of individual trade units with few or no municipalities. Only about 7,000 remaining co- preferences for insiders. This policy was consistent operative establishments are thus subject to the new with what became the predominant thrust of the regulations intended to transform their decision- Czech approach to privatization more generally: to making structures. break the monopoly of the nomenklatura and create Table 2.2: Czech Republic: Estimated Division of State-Owned Trade and Service Establishments According to Method of Privatization Method Number of Establishments Share Percentage Restitution 13,500-16,500 33-40 Small Privatization 23,500 57 Large Privatization 2,000 5 Liquidation 0-3,000 0-7 Total 41,000 100 Note: Estimates are the authors' own. Liquidation is calculated as a residual. Eastern European Experience with Privatization 15 a new class of small-scale entrepreneurs who would 2.7. Finally, some enterprise remnants that sur- support the reform program and the new govern- vived the onslaughts of restitution and small priva- ment. The debate between the second and third tizationwerecorporatized,forinclusioninthelarge lines of argument, what we may term the "insider/ privatization program. Enterprise managers be- outsider debate," turns on much more than simple lieved that they could maintain control of their self-interest. It also concerns the issues of whether companies if the predominant method of transfer shops should be privatized singly or in chains, was to be voucher privatization.' But the situation whether retail should be separated from wholesale was drastically altered by the opportunity given to trade, and what should be done with accumulated outsiders in late 1991 to submit "competing financial liabilities and other obligations. projects" against the "basic projects" submitted by 2.5. The methods eventually applied to privatize the insiders and by the outsiders' prompt response the sector are the outcome of a process in which (see Section D). Furthermore, the astonishing suc- these competingarguments and interests contended. cess of Investment Privatization Funds in early In addition to enterprise managers, restituents, and 1992, which in total attracted 72 percent of all Privatization and Trade Ministry officials, various voucher points, promised to create a less dispersed interest groups attempting to influence asset trans- share ownership structure and therefore increased fers emerged during the process. Among them were the possibilities for effective control, even through a variety of potential new owners: entrepreneurs, voucher privatization. foreigners, and shop managers and workers. The 2.8. The subsequent sections of this country keenest competition for control over assets in the study review the procedures adopted under each of sector was between the new entrepreneurs and the the approaches, the results, and the lessons learned. sector insiders, each representing a distinct political The processes of transformation and divestment of constituency. the cooperative sector are also examined. 2.6. It was particularly the insiders, interested in maintaining control over large supply networks B. Restitution and chains of stores, who attempted to manipulate the process to their advantage. However, they were 2.9. In response to the strong pressure of public blocked by four somewhat independent develop- opinion, the Czech Republic developed one of the ments. First, the new restitution laws made plain most extensive programs of restitution among the possibility that any enterprise assets, particu- former communist countries. A distinguishing char- larly retail units, were vulnerable to reprivatization. acteristic of Czech restitution is its emphasis on For insiders, it was unclear which assets would returning specific assets to their former owners, as remain to provide the basis for corporatization. opposed to providing them with monetary or other Second, the public had little sympathy for the compensation; thus, the program is frequently insiders' plight, and newspapers campaigned against termed "reprivatization."' insider preferences. As a result, Parliament enacted a program that allowed anyone to propose any asset Restitution Laws for sale by auction and granted no preferences to insiders.' Coming early in the overall privatization 2.10. According to the reprivatization laws,8resti- process, this decision was portentous for the com- tution applies only to property nationalized after plete absence of insider preferences enacted in the February 25, 1948, the date on which the commu- subsequent large privatization program, thereby nists assumed full control of the Czechoslovak distinguishing the path ofprivatization in the Czech Parliament. Thus, although most industrial assets Republic from the substantial preferences and ad- were effectively excluded from the restitution pro- vantages received by insiders in other post-com- gram, many shops,' workshops, restaurants, and mand economy countries of Eastern Europe. The hotels, as well as small factories, houses, and plots third development was the start of the small priva- of land, were eligible for reprivatization. tization program in January 1991. The Privatiza- 2.11. Two additional exceptions to the general tion Ministry supported privatizing as much category of "property nationalized after 1948" are property as rapidlyas possible. The policy of"priva- stipulated in the laws. The first exception is finan- tization for its own sake" paid little heed to "tech- cial assets and shares of companies which were nocratic" arguments and tended to favor quick eventually nationalized. It was decided that com- approval of the small privatization proposals.' pensation for financial losses of this sort would be 16 Eastern European Experience with Privatization too complicated to administer. The second excep- suddenly found themselves owning assets which tion was made on moral grounds: subsequently could be used as collateral for obtaining bank nationalized property that had been given as a credit, including for the purpose of establishing reward for aiding the Nazis was not eligible for new businesses. The Czech reprivatization pro- reprivatization. In the event that property nation- gram did, however, cause uncertainties and com- alized after 1948 had later been destroyed, claimants plications for the other privatization programs. were entitled to receive monetary compensation. The six-month app!ication terms may have some- Eligibility for participation in the program was what delayed the implementation ofboth small and limited to resident Czechoslovak citizens whose large privatization.'" For example, the restitution of property was nationalized between February 25, property to more than one owner (which some- 1948 and January 1, 1990. times occurred) led to disagreements over rights of control and property use. While it is not possible to The Process ofReprivatization gauge the program's effect on the transformation of the sector with any precision, it seems clear that 2.12. The law set deadlines for filing restitution restitution was a successful political strategy and claims, and claimants lost all potential rights if they economic policy. Through the program, the Czech failed to submit claims before the expiration of government maintained public interest in privati- these deadlines. Applicants submitted their claims zation and popular support for reform, even during for restitution in the form of a petition directly to the painful period of macroeconomic stabilization the state or cooperative organization using the between 1990 and 1991. At the same time, it may property in question. If the claim was clearly valid also have created a first "critical mass" of private (for example, if only one claimant held proof of businesses. previous ownership), the current user was obliged to either return the property to its former owner C. The Small Privatization Program (SPP) within 30 days, or within this period sign an agreement with the former owner stating precisely Objectives when the property would be returned. The law also stipulates penalties if the current user is responsible for 2.15. The small privatization program (SPP) was any delay in the return ofthe property beyond 30 days. driven by political motivations mingled with eco- 2.13. Disputes regarding restitution claims were nomic arguments. The new government, domi- referred to district courts. District level govern- nated by "radical," free-market reformers, was eager ments were entirely responsible for the administra- to demonstrate its ability to carry our reforms and tion ofredistribution and provided both court and selected trade and services as the first target for notary services to claimants free of charge. In privatization. Although other methods have also addition to disputes arising from competing claims, been significant, the SPP has been the main policy disputes between former owners and current users vehicle for the direct transformation of trade and were also brought to the attention of the courts. services in the Czech Republic. It has accounted for over half of the trade and service establishments Results being privatized. 2.14. Aside from the former German Democratic Legal and Organizational Framework Republic, the Czech Republic has developed the most extensive restitution program of all post- 2.16. The law creating the SPP-established basic communist countries in Central and Eastern Eu- conditions for the selection of assets for the pro- rope. Some 17,000 to 20,000 trade and service gram, auction as the sole method ofdivestiture, and establishmentsareestimatedtohavebeenrestituted. collection of the revenues in a central fund to be These figures, however, do not fully reflect the used to pay the debts of parent enterprises. There impact of restitution on the transformation of the was a corresponding implementation law,' for the trade and service sector. First, the restitution of regulation of small privatization in the territory of residential houses, which are not included in the theCzechRepublic.Therulesgoverningtheexecu- numbers mentioned above, created much ground tion of public auctions and the tax-free status of floor space potentially usable by private entrepre- auction purchases were set forth in various decrees neurs."o Second, recipients of restituted property and announcements.14 Eastern European Experience with Privatization 17 2.17. Three sets of state institutions have been was decentralized, relying primarily on local deci- involved in the program. First, the government and sion-making and initiative. Though District Priva- the Privatization Ministry set the broad outlines of tization Committees selected many assets on their the policy and were responsible for the final deci- own, any person, presumably motivated by the sion on the sale of each property. Second, the possibility of becoming the new owner, could also founding ministries (usually the Ministry of Inter- propose any eligible asset by submitting a proposal nal Trade and Tourism) and state enterprise man- to the Committee. If the Committee approved the agements played a role in the selection of assets. proposal, the state enterprise could still attempt to Third, District (okres) Privatization Committees block the privatization by claiming that the unit were established to recommend assets for the pro- was "technologically necessary" for the continued gram, publish information about assets and sales, operation of the enterprise as a whole. Disputes and administer the auctions. The members of these were resolved in negotiation with the enterprise's Committees, of which there are 20 to 25 in most founding organ and with the Privatization Minis- districts and 70 to 100 for the city of Prague, are try, which made the final determination. appointed by the Minister of Privatization and 2.21. Out of a total of approximately 68,000 include professional employees and representatives trade and service establishments in 1989, it is of the Privatization Ministry and the local union of estimated that 23,272 were privatized through the entrepreneurs. small privatization program as of the end of 1992. 2.18. The small privatization program was by no The law also allowed many other types of assets to means a detailed plan enumerating precisely which be sold in the privatization program, including assets would be privatized in the Czech Republic small manufacturing firms, cars, trucks, and ware- according to a predetermined timetable. The law houses. The number of these items is estimated at specifies only that "the subjects of the ownership 6,779, making altogether a total of some 30,051 transfer ... are movable and immovable assets, as a assets already sold or scheduled for inclusion in the property basis of enterprises that act in the spheres small privatization program. Annex 2.1 shows a of services, trade, and other areas, excluding agri- detailed breakdown of all types of assets in this cultural production" (Article 2). The law also ex- program. cludes properties subject to reprivatization and 2.22. Of the total of 23,272 trade and service those owned or used by persons with foreign resi- establishments in the program, only about 28 per- dency. Two final exclusion criteria played signifi- cent are "full privatizations" (i.e., they were or are cant roles in the struggles over assets in the program. to be sold with the building and land). In the First, the program excludes those considered "tech- remaining 72 percent, the auction winner pur- nologically necessary" to the operation of the par- chases equipment and inventories and receives only ent enterprise. Second, all obligations are excluded: the right to rent the premises for a fixed term. The the assets are sold "unencumbered."" Whether the Small Privatization Law fixed the initial rental term land and building are sold as part of an asset or are for auction winners at two years. Although this is merely leased varies from case to case. Only ifthe lot a rather short time horizon for encouraging invest- of land on which the asset is located is held byastate ment and restructuring, concern over the rights of organization, does the law require that the land and owners to determine the use of their property seems building be sold with the unit, a provision that was to have motivated this provision." A later amend- not applied in the case of multi-unit structures. ment increased the term to fiveyears for subsequent 2.19. Unlike the privatization programs in many auction winners. other countries, the Czech program has imposed 2.23. The fact that the contract with the lessor is few restrictions on the operation of a privatized signed only after the auction has taken place has business. The Small Privatization Law requires cast some potential uncertainty on the object of the only that shops selling groceries must continue bidding. The new business "owners" who have won such sales for a period of at least one year, and the leasing rights must still negotiate with the premises local government is given the discretionary right to owner or administrator over the size of rental shorten this period. The right of alienation is payments, and the District Privatization Commit- attenuated to the degree that sales to foreigners are tees play no role in these negotiations. Because forbidden for a period of two years.' rather stringent rent controls apply to business 2.20. Given the openness of the law, the determi- premises as well as to housing, in many cases the nation of the assets to be included in the program maximum amount of rent could be foreseen in 18 Eastern European Experience with Privatization advance of the auction. But the regulations also about the unit to be sold must be announced 30 contained the provision that local governments days in advance of the auction. Prospective buyers could choose to increase the ceilings or even allow may make two visits to the unit for sale, for a fee of completely free negotiation. However, the Small Kc 50 (approximately US$1.8) per visit." Auction Privatization Law gives the auction winner an participants are required to pay a nonrefundable essentially absolute right to occupy the premises. It entrance fee of Kc 1,000 (US$36) as well as a is thus difficult to evict such a tenant even for non- refundable deposit of either 10 percent of the payment of rent. starting price or Kc 10,000 (US$360), whichever is 2.24. Although selection of assets for the small higher. privatization program was largely finished by the 2.28. The starting price is determined as the sum end of 1992, the District Committees were still of the values of land, buildings, machinery, equip- functioning as of late spring 1993, and it was in fact ment, and inventories. Land is appraised on the still possible for assets to be proposed for the basis of a simplified technical-economic valuation program. What is remarkable about the asset selec- method from which the Czech Ministry of Finance tion process is that it was accomplished in a decen- drew administrative price maps. Book value was tralized fashion, and primarily through private used for other assets. Although it is included in the initiative. The Small Privatization Law merely es- starting price, the cost of the inventories is not part tablished a basic legal framework, and allowed of the purchase price, but instead is paid separately individual incentives and seemingly well-function- to the state enterprise. ing institutions to do the rest. Some 30,000 objects 2.29. Ifno participant is willing to pay the starting were scheduled for auction, with remarkably few price and there are at least five participants, a problems. variant on the "Dutch" auction may be employed 2.25. The equal opportunity for all citizens to in which the price is progressively decreased by participate is a unique feature of the privatization amounts of 10 percent. (In a standard Dutch process in the Czech and Slovak Republics, and auction, the price is usually progressively lowered applies particularly to the small privatization pro- until the object is claimed by the first bidder willing gram. Once assets were selected for inclusion in the to pay the offered price.) If a bid is made during this program, the auctions were open to everyone, with process, the standard auction procedure, with in- essentially no special preferences, including for creasing bids, may be resumed. In the first round, insiders. Of course, insiders may have had an the price can fall to as low as 50 percent of the informational advantage in both the small and large starting value. For items remaining unsold even privatization programs in the Czech Republic, but after their price has been decreased, a second round the absence of lower prices, special credits, and pre- may be held in which the price can decrease to 20 emptive rights for insiders provides a striking con- percent of the starting price. If there is a foreign trast to most privatization programs in other participant(whichispermittedinthesecondround), countries of the region. the price may fall to only 50 percent. 2.26. In the first round, foreigners are excluded from participating. The rationale for the citizen- Results ship restriction is that the program is meant to be a vehicle for the creation of an indigenous business 2.30. By the end of 1992, 21,786 units had been class. Legal persons founded under communism sold through the small privatization program in the are precluded as well, because their participation Czech Republic. The monthly sales for 1991 and could lead to the transfer of the privatized property 1992 are shown in Annex 2.2. The average starting back into state or cooperative hands. Only legal price for all units was Kc 963,000 (US$33,200), persons completely owned by natural persons are while the average final price reached Kc 1,451,000 permitted, and cooperatives of all types are ex- (US$50,000), or 51 percent higher than the start- cluded. ing price (see Annex 2.3). In all, 6,262 units (29 percent of the total) were sold with premises, while The Allocation Process 15,524 items (71 percent of the total) were sold without premises. Dutch auctions were used to sell 2.27. The exclusive method of transfer of owner- 3,453 items (15.8 percentof the total). The average ship rights adopted under the small privatization starting price for those units was Kc 2,537,000 program has been public auctions. Information (US$87,500) and the average final price was Kc Eastern European Experience with Privatization 19 1,344,000 (US$46,300), on average 53 percent of 2.34. Finally, although auctions in general seem the starting price. to offer the best chance for equal participation of all 2.31. It is interesting to note that the lack of interested parties, and the least opportunity for special preferences for employees does not imply corruption, there seems to have been collusion that few former employees acquired the units in among bidders in a fair number of cases, owing to which they worked. A random sample of 100 units the requirement that at least five participants be yielded 53 units whose owners had worked in the present for a Dutch auction to be held. Other units prior to privatization." Former employees irregularities included the purposeful overbidding may have inside information about the value of the by a participantwith insufficient capital, who would assets, and thus it should not be surprising that they then forfeit the deposit in order to have more time have won about half the auctions. to raise more capital to win the auction in the 2.32. Several problems have been identified that second round. Nonetheless, the Czech small are associated with the execution of the program or privatization program seems to have been remark- that involve some aspects of the ownership rights ably successful in avoiding major scandals and in over the assets being transferred. The first concerns reallocating control over a large number of shop the length of rental agreements for premises in premises in a short period of time. transfers in which real estate was not sold. Accord- ing to the Small Privatization Law, the winner of a D. The Large Privatization Program (LPP) lease auction that did not include premises ac- quired the right only to a two-year rental agree- Introduction ment. This clearly raised an incentive problem by shortening the lessee's time horizon. Beginning in 2.35. The large privatization program (LPP)21 October 1991, new leases were signed foran obliga- employs a wide variety of methods of property tory five-year period. A second problem arose from transfer, including "standard methods" of auc- the liabilities left behind in the parent enterprise by tions, tenders, and direct sales, as well as free the auctioning of unencumbered single units. The transfer through the "non-standard" voucher pro- law stipulates that for two years the proceeds of gram. In contrast to the restitution and small small privatization auctions can be used. for the privatization programs, the LPP embraces going satisfaction of claims arising as a result of the law. concerns and shares in corporatized enterprises, in However, the delay in completion of the process addition to unencumbered assets. The organiza- has created problems for the holders of debt. Third, tion of the program is quite complex. This report the sale of inventories together with other assets limits the discussion chiefly to those aspects of large created possibilities for manipulation of the inven- privatization which directly concern the trade and tory value in the period between the auction and service sector of the economy. the moment when the new owner took possession. The law stipulated that the inventory levels and Identification ofAssets for Privatization prices cannot differ significantly from the date of sale, but this is difficult to enforce in practice. 2.36. The identification of assets through the Anecdotes abound of new owners finding useless, large privatization program began in mid-1991. damaged, or low quality inventories, for which they The government classified all state enterprises into are expected to pay. the categories of those to be retained by the state, 2.33. A fourth problem arose from the scarcity of those to be liquidated, and those to be privatized in equity capital and the poor availability of credit. the first and the second "waves" of large privatiza- Credit conditions for the privatization auctions tion. This allocation covered all state-owned enter- were quite restrictive. There was vigorous compe- prises in the Czech Republic, although later splitting tition for less valuable assets from liquidity-con- of companies altered the numbers in each category. strained investors interested in creating a family 2.37. Not all of the assets belonging to the enter- business. In comparison with a situation in which prises designated for large privatization were in- there were well-functioning capital markets, the cluded in the program. Trade enterprises in resultant demand pattern may have raised the rela- particular lost large numbers of assets both to tive price ofsmaller, less valuable items, because few reprivatization and to the small privatization pro- citizens were able to participate in the purchase of gram. The allocation between the small and the larger, more valuable ones. large privatization programs has been a major source 20 Eastern European Experience with Privatization of conflict in the struggle for control over assets in crease the probability that the assets would be the sector. Because in principle any asset could be privatized through a method which preserved their proposed for small privatization, the inclusion ofan control. As is discussed later in this section, manag- asset in large privatization implied one of two ers may have been particularly predisposed toward conditions. First, no one had proposed its inclu- voucher privatization, believing that widely dis- sion in small privatization. Second, the Privatiza- persed ownership would result in ineffective corpo- tion Ministry sometimes ruled against small rate governance. privatization proposals when they did occur, usu- 2.40. Among the trade and service sector projects ally in response to active lobbying by trade enter- approved for large privatization as of the end of prise insiders on behalf of particularly valuable 1992, the largest categories, measured in terms of assets. In either case, the enterprise retained the employment, are hotels, department stores, and asset for the large privatization program. Thus, wholesale trade stores. As was noted above, the although small privatization mostly included large privatization program allows for the employ- "smaller" assets and large privatization included ment of a variety of privatization methods. "Stan- "larger" ones, it is difficult to assess whether the dard" techniques ofauction, tender, anddirectsale, types of trade and service assets differed systemati- conforming closely to Western practice, may be cally across the two programs. All together, only applied to assets, with or without attached obliga- 2,000 trade and service establishments were tions. Whole state enterprises or their sub-units privatized via the LPP, or less than 5 percent of total may be converted into corporate entities and their trade and service establishments. shares sold to foreign and domestic investors. Some 2.38. Three features distinguish large privatization shares are reserved for compensation (restitution),22 from small privatization. The first is that large and both assets and shares may be transferred to privatization can involve the transfer of whole various funds and to municipalities. Finally, "non- enterprises or groups of assets, including those standard" voucher privatization, which involves joined together in a single joint stock company. the exchange of shares in corporatized enterprises The second is that assets can be privatized with for vouchers with which citizens and private funds obligations and as going concerns. The third in- place bids in a multi-round allocation process, is volves the use of a variety of -methods of transfer also allowed. In addition to these methods of including the voucher method and direct sales. privatization, shares may be retained permanently 2.39. Each of these features played a role in the or temporarily in the Fund of National Property negotiations between insiders and privatization (FNP). officials over the division of assets between the small privatization and large privatization pro- The Choice of Method for Privatization grams. Perhaps the most common argument em- ployed by insiders in favor of large privatization was 2.41. The choice of the particular method or the claim that a certain unit (or group of units) combination of methods for privatizing a given made an essential contribution to the operation of enterprise involves selecting a "privatization project" the enterprise, without which the entire network from proposals submitted by enterprise managers would lose viability. Concerning the second fea- or any other interested parties. The management of ture, it is plausible that managers were able to any enterprise subject to large privatization was exclude assets from small privatization by manipu- required to submit a "basic project" first to the lating the profiles of their units. The Small Privati- founding organ and then to the Privatization Min- zation Law states that only "movable and istry. Basic projects included a business plan and a non-movable property" qualifies for sale in the proposal specifying which parts of the enterprise program, effectively eliminating obligations such should be privatized through which method. In as contracts, leases, debts, and apprenticeship re- addition, any other interested parties could submit sponsibilities. On the other hand, since large "competing projects," which did not necessarily privatization can transfer going concerns as well as contain privatization plans for the entire enterprise individual assets, it could be argued that units tied but could focus on the privatization of individual to obligations or unusually heavy financial respon- units or groups of assets. sibilities might be transferred more easily in large 2.42. Although the Privatization Ministry is offi- privatization. By diverting units away from small cially responsible for making the final choice of and into large privatization, managers could in- project or combination of projects to apply to each Eastern European Experience with Privatization 21 enterprise in the program, the District Privatiza- to involving entrepreneurs in the program by en- tion Commissions have often played a significant couraging the submission of competing projects role as well.2' The Ministry typically sends projects was particularly significant in the case of trade and to the local commissions for review and, according service sector assets, because of the prospects for to some estimates, accepts between 70 and 80 growth and relatively low capital requirements in percent of their recommendations. It also appears this sector. Potential investors in these assets would that the founding organs (typically branch minis- have been likely to favor direct sales and other tries, but sometimes local governments) became standard methods. more influential in project evaluation in late 1992. 2.43. Although auctions in this program gener- Results ally follow the same procedures as those conducted in small privatization, the FNP occasionally limits 2.46. Although they are nowhere precisely de- access to participation. In auctions of optician fined, the preferences of the Privatization Ministry shops and pharmacies, for instance, bids were ac- concerning alternative methods of privatization cepted only from registered opticians and pharma- become clearer over time. The Ministry favored cists, respectively. The FNP also occasionally small over large privatization in 1991, a preference attaches restrictions on changes in the line of busi- that diminished in 1992. This choice also reflected ness for assets auctioned in large privatization; for the preference for relatively transparent, competi- example, in pharmacies the activity must be main- tive methods over direct sales. In choosing among tained for at least ten years. alternative methods within large privatization, the 2.44. Tenders are usually evaluated according to Ministry's priorities regarding vouchers versus other three criteria: willingness to assume liabilities, com- methods are more difficult to assess. But a huge and mitment to maintaining the same line of activity, largely unexpected increase in demand for partici- and price. Since virtually all tender bids include the pation in the voucher program in early 1992 de- first two criteria (bids without them are refused creased the average value of property that each almost automatically), it seems that price is by and voucher holder could expect to receive.24 The Min- largethedecisivefactor.Althoughinvestmentprom- istry therefore began to place a higher priority on ises and employment guarantees have been impor- voucher privatization relative to other methods, tant in some widely publicized directly negotiated and on large privatization relative to small sales, they are not standard criteria in most tenders. privatization, in order to increase the value of assets Tenders are thus essentially sealed bid first-price backing the vouchers. At the same time, the possi- auctions. The evaluating committee is appointed bility of generating significant revenues from auc- by the FNP, with a representative from the District tions and direct sales may also have influenced the Privatization Commission. Employing arguments Ministry's preferences for sales over transfers and about non-price criteria, FNP officials have occa- voucher privatization. sionally interfered directly in the tender outcome. 2.47. By far the most important privatization The ensuing allegations of corruption illustrate the method applied in the trade and service sector is pitfalls of the non-transparency of the tender voucher privatization, with 42 percent of the total method. book value. Direct sales account for 21 percent, 2.45. It is interesting to speculate on the motives share transfers 20 percent, and auctions an addi- of the individuals submitting projects. Managers tional 7 percent. Vouchers are particularly impor- may have hoped to influence the process to their tant in wholesale trade stores, restaurants, travel advantage by proposing methods of privatization agencies, and other services; auctions predominate which would allow them to retain some measure of in warehouses; direct sales are important in ware- control. The managers may therefore have viewed houses, supermarkets (see the discussion concern- voucher privatization as attractive, insofar as it ingforeign investors, below),and department stores; could be expected to result in dispersed ownership and share transfers are most significant in travel across large numbers of shareholders, who would agencies and hotels. Information about the privati- be unable to exercise effective corporate gover- zation of Czech wholesale trade is particularly nance. "Outsiders" on the other hand tried to scarce. Although some wholesale units (primarily acquire assets through large privatization, propos- warehouses) were auctioned under the small priva- ing alternative methods of privatization in their tization program, it seems that the newest and most competing projects. The government commitment valuable wholesale trade assets were included in 22 Eastern European Experience with Privatization large privatization, accounting for approximately erative leaders. The net result of the changing legal 50 percent of all storage capacity in the Czech environment may, ironically, have been the main- Republic." tenance of the organizational status quo. 2.48. Although no general restrictions exist on 2.52. In addition to the legal changes, economic who may purchase shares of corporatized compa- circumstances forced cooperatives to alter their nies, or on who may participate in direct sales, operations. Most cooperatives have adopted some auctions, or tenders, participation in voucher mixture of three different strategies to improve privatization is limited to resident Czech citizens their financial condition: (1) leasing of property; over the age of 18, who purchased and registered (2) sale of property; and (3) alterations in the voucher booklets. They could choose to bid their management of cooperative-run stores. voucher points as individual investors or to place 2.53. The transformation of the cooperative sec- them with privately created investment privatization tor can be divided, broadly, into two processes. funds, which would then use them to bid for the One, the legally required process by which coop- shares of companies in the program. The funds eratives were made to conform to new regulations attracted over 72 percent of all points, and the before the end of January 1993, will be called the largest 13 control 40 percent of the total. "legal transformation process." The second pro- 2.49. Though it may have played only a modest cess, whereby individual cooperatives are leasing role in the privatization of the sector as a whole, and selling their commercial premises, will be re- foreign investment has been responsible for several ferred to as "cooperative divestment." The ques- well-publicized direct sales. Through five direct tion of which of these two processes is the more purchases and one majority stake acquisition in the important is related to the terminological problem large privatization program, and the purchase of in defining the scope of cooperative "transforma- one cooperatively owned establishment (in an ex- tion." The difficulty stems from the partially state, cellent location on the Wenceslaus Square in down- partially private character of these cooperatives. In town Prague), the U.S. company K-Mart has created one sense, cooperative transformation occurs when a chain of large department stores in all of the what maybe called the "pseudo-cooperative sector" largest cities in the Czech Republic. Other major is disassociated from the state apparatus, and "au- investors in Czech trade and services include Sara thentic" cooperatives take the place of state-con- Lee of Holland and Tchibo of Germany, both in trolled cooperatives. In this sense, transformation coffee, and Delhaize Le Lion of Belgium, in super- occurs primarily as a result of actions taken by state markets. authorities and the ensuing reconfiguration of the 2.50. Thus, some of the trade and service sector, relationship between cooperative officials and mem- including about 2,000 establishments according to bers. It has little to do with control over individual our estimates, is undergoing privatization in groups, assets. Cooperative transformation can thus be thereby preserving to some degree the chains of viewed as basically equivalent to alterations in the their progenitor state enterprises. In this respect, legal regime regulating cooperatives. Alternatively, the Czech Republic stands midway between Po- transformation can be seen as the transfer of assets land and Hungary. from cooperatives to non-cooperative parties. With this perspective, the identity of the buyers and E. Transformation of Trade Cooperatives sellers of assets and the extent of the property rights being transferred are of the greatest interest, and 2.51. Since 1989, the cooperative sector of the cooperative transformation is essentially analogous Czech economy has undergone several types of to the privatization ofstate assets. Because both sets transformation.6 Legally, cooperatives have been of developments are central to the evolutionary the subject of three separate laws, enacted in 1990, process, we have elected to use the term "coopera- 1991, and 1992. This legislation enhanced coop- tive transformation" to encompass both processes. erative members' rights, cut obligatory ties between district cooperatives and the Union of Consumer Legal Transformation Process Cooperatives, and freed cooperatives to dispose of their assets without governmental approval. How- 2.54. The evolution ofcooperative regulation has ever, decentralization of cooperative decision-mak- been tied to larger political developments in post- ing may have been less significant than were the communist Czechoslovakia. Legislation prior to provisions that served to support entrenched coop- 1990 did not affect the overall organization of the Eastern European Experience with Privatization 23 cooperativesector.TheUnionofConsumerCoop- but the Code permitted their division only into eratives still directed the activities of each of the 73 other cooperatives. The Commercial Code therefore local cooperatives and integrated the activities of mandated that cooperatives remain cooperatives. consumer cooperatives with those of other coop- eratives and state enterprises. New legislation, ef- Divestment ofAssets fective in 1990, produced two categories of reforms: reforms affecting relative power within a given 2.57. Market reforms, the entry of a large number cooperative, and reforms influencing the relation- of new private competitors, and the financial inter- ship between local cooperatives and outside parties. ests of members led cooperatives to divest owner- 2.55. Internal reform occurred through facilita- ship of a majority of their assets through a variety of tion of the movement of capital assets within coop- different processes, some passive and some active. eratives. Assets were shifted to increase share values, Restitution, for instance, was outside of the control which empowered members and also provided an of cooperatives. On the other hand, cooperative impetus for them to monitor cooperative activities. sales, leasing, and abandonment were processes The 1990 legislation made membership in the actively initiated by cooperatives. national cooperative unions voluntary, thereby in- 2.58. As of spring 1993, cooperatives continued creasing the autonomy of individual cooperatives, to run 7,089 of the 26,250 shops and catering Also, the requirement for governmental approval establishments operated in 1989. Outofthe 19,161 ofsale of local cooperative assets was abolished. The businesses which are no longer operated by coop- first freely elected government, seated in mid- eratives, an estimated 3,500 units were lost through 1990, empowered members to assert their demo- restitution, and an additional 3,972 businesses are cratic rights and the control of their cooperatives. currently leased to private individuals.29 The re- 2.56. Cooperatives, like all other legal forms, were maining approximately 11,700 premises have been initially regulated by the Commercial Code of sold, ceded to municipalities, or abandoned. There 1991.2- Provisions pertaining to cooperatives re- is, unfortunately, no reliable way to further subdi- mained essentially unchanged from those in the vide this number. Nonetheless, the movement of 1990 law. Cooperative property was not treated as over 19,000 premises out of the control of con- analogous to state property. However, the "Trans- sumer cooperatives makes cooperative divestment formation Law"28 required cooperatives to go one of the most significant retail sector transforma- through a special process to ensure that their inter- tion processes in the Czech Republic. All pre-1989 nal by-laws were in accordance with Code provi- cooperatives continue to exist but they do so with sions. The law required that all cooperatives either far fewer members. Cooperative membership be transformed by January 28,1993 to conform to slipped from 1.42 million in 1989 to 840,000 at the the structure prescribed under the Commercial end of 1992. As of March 1993, consumer coopera- Code or be liquidated. Both the Transformation tives were leasing out 2,768 shops and 1,204 restau- Law and the Commercial Code in fact heavily rants to private parties. While complete information promoted the maintenance of the existing coopera- about lease conditions cannot be obtained, a Priva- tive structures. First, the Transformation Law in- tization Project case study reveals the existence of cluded a provision that both minimized the two types of leasing arrangements.30 Less desirable revaluation of cooperative membership shares and units were rented for a defined period with few lease de facto ruled out the liquidation of cooperatives. conditions. In a second group of stores, the lease Each cooperative was required to set aside 75 contract was similar to a franchise arrangement. percent of its assets in an "indivisible fund." If the Lessees were required to maintain the business cooperative were to be liquidated within the ten name and to purchase the same goods from a years following the adoption of the law, the entirety defined supplier." of the indivisible fund (remaining after debts are 2.59. At the end of the "legal transformation paid) would be transferred to the Fund for National process," consumer cooperatives in 1993 bore a Property. While the Transformation Law ensured striking resemblance to their 1989 forebears, al- that cooperative assets would not be distributed though they were not identical. Most members are through liquidation, the Commercial Code en- largely passive, but a core group continues to have sured that cooperatives were not split up into other strong incentives to participate actively in coopera- legal forms. Cooperatives were allowed to divide tive management. Members who are cooperative their assets to form other economic organizations, officials and employees (all employees are coopera- 24 Eastern European Experience with Privatization tive members) have significant economic interests mate that cooperative stores purchase 50 percent of in cooperative functions. their supplies from other cooperatives, a significant 2.60. All consumer cooperatives continue to be increase from the 30 to 40 percent level of intra- members of the Union of Czech and Moravian cooperative sourcing in the pre-1989 period .3The Consumer Cooperatives, but the Union's function creation of a Cooperative Bank and the attempt to has been significantly altered. Previously, the Union form a central cooperative purchasing agent are served as the managerial center of the cooperative evidence of the efforts to establish stronger eco- sector, largely controlling the actions of local coop- nomic links among cooperatives. eratives. It now serves as a source of technical 2.61. Cooperatives exist today as the single re- support for member cooperatives. In addition, maining owners and operators of substantial retail cooperatives are making a concerted effort to sup- networks in the Czech Republic. The advantage port each other. After an initial period in 1990-91 that cooperatives hold over independent, indi- when local cooperatives sought to establish their vidual business establishments in terms of econo- independence, cooperatives are actively pursuing mies of scale, negotiating power, and access to strategies, coordinated by the Union, to promote capital could prove to be significant in the future the cooperative sector. Cooperative officials esti- development of the Czech retail sector. Notes compensation in some situations, for instance for de- stroyed property. 1. Data for the nearly 3,000 hotels (plus motels, pensions, 8. Two principal laws and amendments to these laws now and camps) do not permit the classification of these units regulate the restitution of property in the retail trade, by ownership, and the 2,000 service units of municipali- catering, and services sector of the Czech economy: Law ties were seriously undercounted, since many service units No. 403/1990 "On Relieving the Consequences of Some existing at the time were integrated into larger enterprises Property Injustices" (Small Restitution) and its amend- conducting other activities. ments, and Law No. 87/1991 "On Our-of-Court Reha- 2. In the Czech Republic, as in other post-communist coun- bilitation" (Large Restitution). tries, there was no doubt also some "spontaneous privati- 9. Among these shops were many nationalized family busi- zation," whereby enterprise managers sold or transferred nesses, attached to the living quarters of the previous assets to the private sector and/or out ofstate control. The owners. They were perhaps the easiest to privatize through most obvious transactions were forbidden after March restitution. In many cases not only was there a single, 1991, but it is speculated that a large number ofassets may undisputed, previous owner, but quite often that previous have been sold until that date. owner was still living on the premises and still operating 3. Many of the premises used by cooperatives in rural are the shop. were actually owned by local governments, which have in 10. As a qualifier, we should point out that although there are numerous cases recently reclaimed their ownership rights. no restrictions on the use of restituted property in partic- 4. Insiders were not prohibited from participating in the ular, there exist rent controls and eviction regulations on small privatization program. The results of our establish- property which has been used as residential space, which ment survey, discussed in this report, indicate that about also affect the use of rescituted property for business half the small privatization auctions were won by former purposes. It seems that rent ceilings are so low, and the shop employees. Although we have no data on the extent restrictions on tenant evictions so stringent, that available to which former Ministry of Trade officials or enterprise ground floor business space has remained extremely tight. managers became new owners, it seems that insiders may 11. Although the argument that restitution would stall other have been able to use their informational advantages to quick" privatization (small and large privatization) retain some of their former control. schemes was one of the most important objections to a 5. Any asset was fair game to be proposed for small privati- restitution program, neither small nor large privatization ration until the Privatization Ministry gave final approval has proceeded as quickly as originally had been hoped. to a large privatization project containing that asset. In 12. Law No. 427/1990, Coll., "On the Transfer of State 1992, the Ministry partially reversed its priorities to Ownership of Certain Properties to Other Legal or Nat- increase the supply of assets to the voucher program. ural Persons." 6. They may also have attempted to arrange sweetheart deals 13. Law No. 500/1990 Coll., "On Competencies of Czech with outside investors, or even to acquire the assets directly Republic Governmental Bodies in the Matter of Transfer themselves, but such possibilities were constrained by the of State Property to Some Things to Other Legal or requirement for approval from the Privatization Ministry. Physical Persons." 7. By avoiding the need to determine the value of formerly 14. The rules for public auctions were stipulated in Decree of confiscated property, reprivatization may be much sim- the Ministry of Privatization No. 535, and the tax-free pler than compensation. The problems of reprivatization status of auction purchases was announced by Federal in determining legal ownership, on the other hand, are MinistryofFinanceAnnouncementNo. 90/1990/1 Coll., avoided with compensation. The Czech program does use "On the Tax-Free Status of Auction Purchases." Eastern European Experience with Privatization 25 15. The provision that units with liabilities could be privatized 23. During the First wave of large privatization, the District only in the large privatization program may be considered Privatization Commissions were occupied with the ad- the most important legal distinction between the kinds of ministration of small privatization auctions, the purpose assets covered by the two programs. for which they were created. Since the volume of small 16. This is true if the auction is completed in one round, privatization sales began to dwindle in late 1992, the which implies that the purchaser must be a citizen. If the District Commissions have begun to assume a larger role auction requires multiple rounds, which allows the possi- in large privatization, often executing auctions and par- bility of a foreign purchaser, then the resale restriction no ticipating in the evaluation of tenders. longer applies. 24. Although less than a half million voucher holders were 17. Among these owners are restituents, to whom many registered at the end of 1991, participation soared in business premises were returned and who have now be- January 1992, with 8.57 million registered by the end of come lessors, and municipalities, to which many premises February, the final deadline. This unexpected increase is have been transferred. The transfers to municipalities take usually attributed to the spectacular offers by Investment place under Law 172/1991, according to which munici- Privatization Funds of guaranteed 900 percent rates of palities have restitution rights to property they owned return. prior to 1949. This law also allows municipalities to apply 25. Based on evidence collected during an interview with the to the Ministry of Finance to receive any state-owned Czech Ministry of Industry and Trade, in May 1993. property. Municipalities have become important land- 26. Consumer cooperatives were not the only cooperative lords, although as business operators they are much less form operating in the retail trade and service sector. important than formerly. Producer cooperatives were also significant providers of 18. We use theexchange rateofUS$1 = Kc 28,which has been services. However, the inadequacy of the data on service roughly constant over the 1991-93 period. units in the Czech Republic precludes analytical study. 19. Because of suspected collusion among bidders, the proce- This section will, therefore, deal exclusively with con- dure was amended in 1992 to permit the price to fall only sumer cooperatives. in the second round and only to 50 percent of the starting 27. Law No. 513/1991. price, in the case of sales of premises. 28. Law No. 42/1992, the Law on the Regulation of Property 20. This random sample was taken from the total 15,231 retail Relations in Cooperatives. trade, catering, and service units already sold as ofDecem- 29. Unpublished statistics, Union of Czech and Moravian ber 12, 1991 (see Chapter V, Survey). Consumer Cooperatives. 21. Initiated by Law No. 92/1991, "On Conditions and Terms 30. The case study was conducted on a consumer cooperative Governing the Transfer ofState Property to Other Persons." operating 98 retail stores, with 15,465 members. 22. These shares are distributed as compensation to those 31. Lessees had the right to select their own suppliers for any entitled to reprivatization under the restitution laws but additional goods they chose to sell. whose expropriated property was destroyed auring the 32. Privatization Project interview with the Union of Czech period of state control. and Moravian Consumer Cooperatives (May 12, 1993). 26 Eastern European Experience with Privatization Annex 2.1: Czech Republic: Structure of Items Scheduled for Small Privatization as of December 31, 1992 No. of Items No. of Items Total No. of Items with Premises without Premises Retail Trade Shops 15,452 3,727 11,725 Of which: Sweets, candies 321 262 59 Household necessities 2,409 419 1,990 Kiosks 654 70 584 Newspapers and tobacco 2,462 40 2,422 Shoes and leather 305 52 253 Department stores 70 63 7 Food shops 3,903 1,828 2,075 Books, old prints 337 16 321 Furniture 107 36 71 Florists 405 53 352 Textiles and clothing 1,404 177 1,227 Butchers 912 158 754 Vegetables, fruits 1,271 328 949 Bakeries 128 111 17 Petrol stations 165 133 32 Other shops 599 190 409 Restaurants 2,424 911 1,513 Services 5,396 1,831 3,565 Of which: Hotels 577 489 88 Other services 4,819 1,342 3,477 Other Items 6,799 1,497 5,282 Of which: Cars, means of transport 4,020 46 3,974 Warehouses 592 389 203 Production units 730 357 373 Factories 211 152 59 Houses and offices 269 206 63 Transportation 77 27 50 Cultural houses 34 22 12 Computer centers 8 1 7 Others 838 297 541 Total 30,051 7,966 22,085 Source: Ministry of Privatization. Eastern European &perience with Privatization 27 Annex 2.2: Czech Republic: Number of Items Sold in Small Privatization, 1991-92 (All items) Cumulative Average Average Ratio of Number Number Starting Price Final Price Final Price to Month Year of Units of Units in Kc 1,000 in Kc 1,000 Average Price (%) January 1991 16 16 139 1,365 982 February 1991 69 85 163 290 178 March 1991 829 914 302 549 182 April 1991 1,831 2,745 407 647 159 May 1991 1,709 4,454 436 612 140 June 1991 2,307 6,761 742 1,014 137 July 1991 1,221 7,982 885 1,236 140 August 1991 1,414 9,396 1,051 1,217 116 September 1991 1,622 11,018 916 1,308 143 October 1991 1,897 12,915 1,624 2,447 151 November 1991 1,293 14,208 558 1,192 214 December 1991 1,023 15,231 637 1,622 255 January 1992 1,074 16,305 1,013 1,765 174 February 1992 904 17,209 1,507 2,258 150 March 1992 802 18,011 1,142 1,871 164 April 1992 759 18,770 1,151 1,719 149 May 1992 767 19,537 1,214 1,582 130 June 1992 611 20,148 1,625 1,844 113 July 1992 395 20,543 1,579 2,270 144 August 1992 329 20,872 1,962 2,714 138 September 1992 303 21,175 1,799 2,957 164 October 1992 286 21,461 1,602 2,536 158 November 1992 177 21,638 1,626 2,935 181 December 1992 148 21,786 1,878 2,358 126 Source: Ministry of Privatization. 28 Eastern European Experience with Privatization Annex 2.3: Czech Republic: Structure of Items Sold in Small Privatization as of December 31, 1992 Average Average Ratio of Total No. Starting Price Final Price Final Price to of Items In Kc 1,000 in Kc 1,000 Average Price (%) Retail Trade Shops 12,782 671 1,185 177 Of which: Sweets, candies 271 449 1,051 234 Household necessities 1,998 437 993 227 Kiosks 462 254 321 126 Newspapers and tobacco 2,230 26 187 718 Shoes and leather 176 335 554 170 Department stores 54 15,014 20,965 140 Food shops 3,357 1,194 1,814 152 Books, old prints 259 113 554 488 Furniture 84 1,299 2,689 207 Florists 335 139 670 483 Textiles and clothing 1,107 358 968 270 Butchers 763 401 841 210 Vegetables, fruits 1,076 397 732 184 Bakeries 99 4,315 5,630 130 Petrol stations 119 1,175 4,217 359 Other shops 392 1,511 2,133 141 Restaurants 1,824 1,146 1,791 156 Services 3,936 1,131 1,498 132 Of which: Hotels 427 3,576 5,939 166 Other services 3,509 833 958 115 Other Items 3,244 1,823 2,253 124 Of which: Cars, means of transport 1,528 174 158 91 Warehouses 422 2,416 2,830 117 Production units 482 3,515 3,399 97 Factories 136 11,280 16,186 143 Houses and offices 157 1,105 1,914 173 Transportation units 41 4,121 4,138 100 Cultural houses 17 1,194 925 77 Computer centers 3 969 822 85 Others 458 2,261 3,375 149 Total 21,786 963 1,451 151 Source: Ministry of Privatization. Chapter Three Poland A. Introduction of retail trade, catering, and consumer services centered not around the privatization of the sub- 3.1. Poland has achieved the most rapid trans- standard businesses run by the command economy's formation of the retail, catering, and service sectors domestic trade sector, but around a transfer of the in all of Central and Eastern Europe. Officially, real estate on which these businesses had been over 97 percent of all shops and other consumer operated. Thus, the salient features of small priva- outlets in Poland are now private; although these tization in Poland had little to do with a transfer of statistics are not fully reliable, the extent of the ownership in businesses as "going concerns," or transformation is undeniably high. Perhaps the with ensuring the continuity of operation of old most interesting fact about the small-scale privati- state-run stores and outlets. The essence of small zation in Poland is that the government never privatization in Poland was a transfer of interests in mandated or legislated its occurrence. In contrast commercial premises to private parties. While these to other countries, in Poland there was no separate interests were most often narrower than full own- small privatization "program," and the impact of ership rights, all laws, regulations, and policy pre- the general privatization law was minimal. Instead, scriptions created to govern the transfer of the use a series of governmental acts, unrelated to privati- of real estate shared a common theme, namely, the zation per se, released a spontaneous and largely harnessing of private initiative for the purpose of unregulated process in which the existing special creating market conditions ofaccess to commercial interests were pitted against each other and were property. enlisted in the cause of transformation. While 3.3. The implicit objective of governmental many aspects of the rapid change in Poland can be policy measures was to dissolve the state-run trade attributed to the macroeconomic reforms intro- network, not to preserve it. Insofar as the retail duced in January 1990, and while other aspects units themselves were concerned, there was little of may be due to unique local conditions, the "case of value in them beyond the premises that could be Poland" contains important lessons for other coun- used productively in the aftermath of the transfer. tries that are restructuring their consumer sectors, Given the impoverished state of the sector, the especially the newly emerging nations of the former equipment of state and cooperative stores was not Soviet Union (FSU). worth very much, and the inventory was either nonexistent or so substandard that even the chronic Transfer of Real Estate shortages ofthe command economy period had not sufficed to get rid of it. With the new influx of 3.2. The key to the rapid rate of small imported goods' and rapidly rising consumer ex- privatization in Poland has been the realization on pectations, the inventory was in fact likely to the part of the government that the transformation become a liability. 30 Eastern European Experience with Privatization 3.4. Two consequences followed from this focus was delivered with astonishing speed, and the large on real-estate utilization. First, since the old stores trade organizations, which in the other countries and outlets were essentially "stripped" to their real- (with the possible exception of former Czechoslo- estate skeletons, and since the new businesses as vakia) have very effectively resisted a radical restruc- much as the old ones needed access to largely state- turing of their sector, were weakened beyond repair. controlled commercial premises, the distinction While the "surgical" removal of the premises owned between "start-up" and "privatized" units became by local authorities and housing cooperatives was rather fluid. While most of the new businesses were accomplished with great efficiency, the privatiza- undoubtedly private, the state has often preserved tion of the remaining retail and service units in the its title to the premises on which both the new and former socialized sector was a much more difficult the "privatized" units are operated, with the busi- and somewhat less successful operation. This pro- nesses usually acquiringonlyhighly restricted, short- cess took different forms in the state and coopera- term use rights. The main feature of small tive sectors. privatization in Poland, then, has been not a con- 3.7. The privatization of the rump state enter- ferral of important property rights on private par- prises has been the only part of small privatization ties, but rather a destruction of the old system in that took place according to the more general which large socialized enterprises controlled the procedures prescribed by the Polish Privatization most valuable real estate necessary for the develop- Law. The dominant form of transformation here ment of a genuinely private retail trade sector. has been the so-called "privatization through liqui- 3.5. The second consequence of the focus on real dation," which involves a sale or lease of enterprise estate was the ability of policy makers to bypass the assets to a company formed by the employees. old state domestic trade organizations (consumer Although it is the most decentralized of the Polish cooperatives and state enterprises), which were not privatization programs, it is fairly tightly controlled interested in construction and ownership of pre- by the founding organ (most commonly the voivoda mises in which their stores were located, but instead office)' and the Ministry of Privatization, and its leased them at low prices from other state institu- progress in the domestic trade sector has been slow. tions and housing cooperatives. Thus, the owner- 3.8. The privatization of the consumer coopera- ship of real estate was in most cases separated from tive sector, which controlled the greatest number of the ownership of retail businesses, but this fact was stores in Poland, is the most complex and the least without significance as long as the allocation of studied part of Polish small privatization. Privatiza- commercial space was based on planning decisions tion of this sector began immediately after the fall rather than market mechanisms. One of the early of the last communist government, with a law acts of the Mazowiecki government, however, was dissolving central and regional associations of co- to restore genuine property rights to the previous operatives. The dissolution of the associations had merely titular owners of real estate. The local gov- a twofold impact on the development of small ernments and housing cooperatives, the main ben- privatization. First, the liquidators appointed to eficiaries of this change, had no interest in manage the dissolution process were charged with preserving the old empires of state trade organiza- disposing of the property of the associations. This tions, which had been run on a centralized basis and led to a large-scale release of assets crucial to the had maintained no real ties to the local communi- formation of private wholesale and distribution ties. For the newly enfranchised owners of real systems, and contributed a very important element estate, the only potential obstacles to their takeover of "upstream" restructuring. Second, the dissolu- of state and cooperative stores, particularly in the tion of cooperative associations essentially decapi- case of local authorities, were the employees of the tated the state-dominated cooperative system, and local units, who had local connections and the set local cooperatives adrift. sympathy of their neighbors. The result was an 3.9. The elimination of the associations and the alliance between local authorities and the insiders loss of units as a result of the termination of old from the affected units, who turned against their administrative leases opened the door to a decen- old employers and went into business for them- tralized process of transformation for local coop- selves. eratives. Large numbers of cooperative units were 3.6. State enterprises were thus deprived of most effectively privatized by being leased or franchised of their stores, and consumer cooperatives suffered to private individuals, most often member-em- very significant losses as well. The near-mortal blow ployees. Other units are still run by the cooperatives Eastern European Experience with Privatization 31 themselves, but they too have been "privatized" provide an important lesson for other countries. with a stroke of a bureaucrat's pen: they were Unless the government is extremely strong and simply reclassified as no longer belonging to the insiders are incapable of mounting effective resis- "socialized" sector. tance (which seems not to be the case in most post- command economy countries), there is a clear Insider Domination trade-off between the speed of small privatization and an open, competitive method of allocation. 3.10. As is obvious from what has been said, the But the problems raised by insider domination are process of small privatization in Poland has been also serious, since insiders are less likely to restruc- dominated by the employees of the former state ture and invest in the newly privatized businesses.3 and cooperative units and by local government The results of the survey show that post-privatiza- insiders, with the central government skillfully tion investment levels in Poland are significantly manipulating the incentives of all parties. An over- lower than in Hungary or the Czech Republic. whelming majority of the previously socialized units (or the premises on which they were located) Scope of the Transformation have accordingly been allocated on the basis of a closed procedure and at prices that most often have 3.11. The extent of transformation of Poland's not reflected their market value. Insider domina- retail and service sectors is analyzed in Table 3.1. In tion in part explains the speed with which small aggregate, between 1989 and 1992 the number of privatization was achieved in Poland, and this may socialized retail, catering, and service outlets de- Table 3.1: Poland: Ownership Transformation in Retail Trade, Consumer, and Service Sectors (Thousands of Units) 1989 1992 % Change Total Retail Outlets' 249 7502 301 Socialized 178 33 (82) Private 72 717 996 Total Retail Shops 151 3532 234 Socialized 124 9 (93) Private 27 3443 1,267 Total Catering Outlets 31 53 171 Socialized 16 1 (94) Private 15 52 347 Total Service Outlets 255 209 (18) Socialized 42 8 (81) Private 213 201 (6) Total Outlets in Retail, Catering, and Service Sectors 535 1,012 189 Total Socialized 236 42 (82) Total Private 300 970 323 Outlets include shops as well as kiosks, stands, booths, and other small points of sale. 2 Estimated by GUS from a preliminary tally of year-end statistical reports. Includes approximately 46,000 stores run by cooperatives and other social organizations. Sources: GUS Statistical Yearbooks 1989-92; Institute of Internal Market; Pentor; Institute for Opinion and Market Research, Warsaw; and various interviews with representatives from the Domestic Market Department of the Main Statistical Office. For 1989, socialized units include state-owned and cooperative units, as well as units owned by so-called "social organizations." For 1992, cooperative units have been reclassified as "private" by Polish statistics. 32 Eastern European Experience with Privatization clined 82 percent, from 236,000 to 42,000, while employing others increased fivefold, from 93,900 the number of private units increased over 320 in 1989 to over 470,000 in 1991, and amounted to percent, from 300,000' to 970,000. The largest over 30 percent of total employment (up from only shift in the ownership structure occurred in the 6.5 percent in 1989). retail sector, where the number of private outlets 3.13. Whilethepresentstudyismostlyconcerned increased by an extraordinary 996 percent, from with privatization in the narrower sense of the term 72,000to717,000.Thenumberofprivatelyowned (i.e., a process by which formerly socialized units retail stores, a subset oftotal retail outlets, increased were replaced by private businesses operating on by 1,267 percent, from 27,000 to 344,000 stores. the same premises), the transformation of the do- Private catering businesses grew 347 percent, from mestic trade sector in Poland, especially in the early 15,000 to 52,000, and socialized catering units period of the reforms, was also driven by the declined 94 percent, from 16,000 to approximately emergence of new businesses, operating on pre- 1,000. In the area of non-material services, where, mises previously occupied by other types of state- even under the command economy, private outlets run businesses, as well as in makeshift locations, contributed over 43 percent of total turnover, the often on the streets or vacant lots. These new number of units actually declined by 6 percent, businesses, generally small kiosks and stands selling from 213,000 to 201,000. This decline is attrib- alimitedandoftenchangeableassortmentofgoods, uted to the general economic slowdown and lack of account for over two-thirds of the growth in the demand. The numerical changes in the sizes of the number of units between 1989 and 1992. Despite private and socialized sectors may appear some- their small size and often transitional existence, this what more dramatic than the underlying reality, increase in small private outlets played an impor- since a large number of cooperative and other rant role in creating a genuinely competitive envi- "socialized" units have been simply reclassified as ronment in which both the remaining state stores "private" (ca. 46,000 shops alone were "privatized" and the newly privatized units had to operate. The in this way). Even without counting the coopera- more dynamic new small businesses quickly filled tive units, however, the growth of the private sector temporary gaps in supply, and also forced other has been extremely impressive. The overall increase units to modifv their behavior, with overall gains in the number of units has dramatically improved for the efficiency of the entire domestic trade sector. the access of Polish consumers to retail stores. 3.14. The mainstream privatization process, in- Between 1989 and 1992 the total number of retail volving the establishment of private businesses on shops increased from 4 to 9 units per 1,000 people, the premises formerly occupied by socialized units, and catering outlets increased from .8 to 1.4 units is the main object of the present study. The pro- per 1,000 people.5 cesses examined in the subsequent sections involve 3.12. Changes in the ownership structure and the the privatization of approximately 69,000 retail size of the domestic trade sector are also reflected in stores and 76,000 smaller retail outlets, 15,000 changes in the structure of employment. Total catering units, and 34,000 service outlets - in employment in the sector grew 6 percent, from 1.4 total, approximately 82 percent of the former so- million to 1.5 million, between 1989 and 1991.6 cialized sector trade network. Official data on the This increase may seem modest, but the official number of shops and other units privatized by the numbers probably understate the increase in real many gminas (municipal governments), state en- employment in the private sector, since private terprises, and consumer and housing cooperatives owners commonly under report the number of are largely unavailable. But the researchers in the their employees (often family members) in order to Privatization Project of the Central European Uni- evade the extremely high social security and wage versity (referred to hereafter as the CEU Privatiza- taxes. Also, the increase in employment in the trade tion Project), have pieced together estimates of sector should be considered in light of the overall units privatized by various governmental authori- growth of unemployment, which reached 12 per- ties, state enterprises, and cooperatives. The esti- cent of the labor force during the same period. In mates are presented in Table 3.2. addition to an overall increase in employment, there was a proportionately much larger increase in B. Changes in the Real Estate Market in 1990 the number of self-employed, reflecting the shift away from state dominance toward private owner- 3.15. Prior to 1990, the use and disposition of, ship. The number of self-employed and persons commercial premises by both private and state Eastern European Experience with Privatization 33 parties was strictly controlled by the HousingActof regime as a result of a provision in the Law on 1974. Essentially, the Act gave the state a pre- Cooperatives of 1982, which obliged them to fol- emprive right to use any commercial property if a low the "social economic plan," as implemented by socialized (i.e., state or cooperative) enterprise the local planning council. Similarly, while the needed the premises to conduct economic activi- system of administratively set prices did not for- ties, or if the property was made part of a master mally apply to the housing cooperatives, they were plan for the allocation of retail or service outlets in not supposed to have been profit motivated and a given area.' Rental arrangements with socialized their pricing was based on an artificially calculated enterprises were made on the basis of an adminis- cost basis. In practice, the cooperative rents were trative decision (with no negotiated, bilateral leases), usually lower than the administratively set rents for and the property could be sold or leased only at the premises that were owned by the municipalities. prices set administratively by the Council of Min- 3.17. The enforcement of the Housing Act and isters. This "special renting mode," as the system the related cooperative regime created strong disin- came to be called, meant that a committee of local centives for socialized enterprises to invest in their officials decided on the "best" use of each available own premises, since the rents on premises they unit, and then chose an appropriate state enterprise obtained from the state were set very low and lease or consumer cooperative to run the prescribed type terms were of indefinite duration.! of business. 3.18. The 1990 Amendments to the Housing Act 3.16. Although the Housing Act did not formally of 1974 gave real estate owners genuine rights to apply to housing cooperatives, which owned a dispose of commercial premises and created new significant portion of commercial real estate, the incentives for these owners to make better use of cooperatives operated under essentially the same existing commercial space. A casual perusal of the Table 3.2: Poland: Estimates of Retail Stores and Catering and Service Outlets Privatized by Various Groups of Owners, 1992 (Thousands of Units) Retail Stores (Excluding % of Catering % of Service % of Smaller Outlets)' Total Outlets Total Outlets Total Total % of Total Gminas' 32 47 7-9 47-60 20 59 59-61 50-52 State-Owned Enterprises' 3-5 4-7 1-2 7-13 1-3 3-9 5-10 4-8 Consumer Cooperatives' 20-22 29-32 2-5 13-33 7-9 21-26 29-36 25-31 Housing Cooperatives' 12 17 1-2 7-13 4-5 12-15 17-19 14-16 Total 69 100 15 100 34 100 118 100 I Despite several attempts to compile information on the proportions of some 76,000 smaller non-shop retail outlets privatized by various entities, the size and the location of these outlets have prevented accurate estimates from being made. These outlets, which were often small stands or kiosks, were therefore omitted from this table. 2 Data on gminas are based on reports from the Central Planning Office, interpolations using official data on changes in the number of socialized sector shops, a survey conducted by the CEU Privatization Project, and data from the Ministry of Privatization; data on state- owned enterprises are based on proportions revealed in surveys conducted by the CEU Privatization Project and data from the Department of Domestic Market at the Main Statistical Office; data on consumer cooperatives are based on information from the Main Statistical Office, proportions revealed in surveys conducted by the CEU Privatization Project, and interviews with various government officials and include only units actually conveyed to private hands and not units which continue to be operated by cooperatives (which have also been reclassified as "private"); data on housing cooperatives are based on interviews with officials from the Housing Cooperative Institute, proportions revealed in surveys conducted by the CEU Privatization Project, and data interpolations. Source: CEU Privatization Project. 34 Eastern European Experience with Privatization 1990 Amendments would not have revealed any- authorities often took over. As a result of this new thing out of the ordinary. The new provisions independence, the management of the local hous- simply stated that commercial premises hitherto ing cooperatives became much more responsive to rented on the basis of administrative decisions the needs of the cooperative residents (members). were, effective immediately, to be governed by the This series of events, more or less concurrent with appropriate provisions of the Civil Code. The the Housing Act Amendments, initiated a parallel "trick" was that the Civil Code gave the owner of wave of terminations of the leases between housing the premises essentially unlimited freedom to ter- cooperatives and state enterprises or consumer co- minate any lease of indefinite duration. TheAmend- operatives, with the resulting privatization of many ments thus released municipalities and other parties shops, restaurants, and service outlets. In a matter of a from previous administrative controls, and con- few months, the large majority of commercial pre- ferred upon them a right to dispose, essentially at mises in Poland were allocated to new users, and the will, of the suddenly extremely valuable assets. The real estate market was changed beyond recognition. Amendments gave the existing tenants three months to renegotiate their rental agreements, after which C. Municipal Government (Gmina) Privatization the owners could evict them. The only right left to the old tenants was their ability to recover the 3.21. Perhaps the main beneficiaries of the resto- expenses incurred for reconstruction, restoration, ration of genuine ownership rights in commercial or modernization of the premises. real estate were the municipalities, which had owned 3.19. The immediate result of the Amendments a large portion of commercial premises, especially was that real estate owners asserted their ownership in urban areas. The following discussion covers the rights in order to obtain an economic return on processes used by municipal governments (gminas) their assets. Where new leases were auctioned, in Poland to privatize a large number of retail, rentals rose to exorbitant levels which inefficient service, and catering outlets that devolved on them state enterprises could no longer afford. When through the 1990 Amendments to the HousingAct property was allocated by other criteria, state enter- of 1974 and the new Law on Local Self-Govern- prises were not the favored party. The net result was ment. a massive transfer of real estate use to private enter- 3.22. The Law on Local Self-Government, en- prises. One of the side effects of this "mass exit" was a acted on March 8, 1990, conferred on the gminas disintegration of old retail empires which, deprived the ownership and control over all property under of a large proportion of their units, were commonly the control of the former basic territorial units of pushed into bankruptcy or liquidation, the central administration. The passage of the 3.20. Although housing cooperatives were not Housing Law Amendments coincided in time with subject to the Housing Act and thus were not a large-scale restructuring of municipal govern- affected by the 1990 Amendments, a parallel pro- ments, which gained a large degree of indepen- cess of reform also released them from the old dence from central authorities. One aspect of the structures and conferred on them genuine owner- devolution of authority effected through the law ship rights to the commercial premises in their was a transfer to the newly created municipal buildings. Formally, the housing cooperative leases governments of ownership rights to large amounts had always had the form of bilateral agreements of commercial real estate, together with nearly rather than of the "administrative leases" under the complete autonomy to determine the purposes and Housing Act, and the standard lease used by hous- uses ofthese properties. This transfer process, known ing cooperatives allowed either party to terminate as "communalization," became one of the major at any time, with only minimum notice. Under the catalysts for the development of the private trade command economy, housing cooperatives did not sector. This section is based on a series of interviews negotiate the length of the lease in advance. The with local officials and an empirical survey of a demise of the old regime, however, brought about random sample of 100 gminas conducted by the a change. The precipitating event was the 1990 Law CEU Privatization Project in March 1993. Governing Cooperatives, which abolished the old cooperative associations that previously controlled The Process of Gmina Privatization the local cooperatives and also effected restructur- ing on the local level. Many local housing coopera- 3.23. There are 2,700 gminas in Poland. In the tives split into smaller units, for example, and new absence ofa centrally imposed, uniform procedure, Eastern European Experience with Privatization 35 "gmina privatization" has in fact been an amalgam- stood that, with communalization, they could be- ation of 2,700 individual programs of ownership come proprietors, if suitable arrangements could be transformation. Indeed, the very idea of a "pro- made with the local authorities. These insiders were gram" may overstate what took place: in 87 percent local people, with local ties and loyalties, and they of the gminas examined in the CEU Privatization argued that a transfer of their units to outsiders Project's survey, the process took place without a would drive up rents and lead to bankruptcies, formal privatization plan approved by the elected social upheavals, and disruptions ofsupplies. Unions bodies of the gminas.' also constituted an important factor, defending the 3.24. The municipal departments responsible for rights of insiders to continue operating their units, the disposition of communalized property began and sometimes backing their demands with the their work by preparing claims to the assets covered threat of strikes. Presumably, the insiders also used by the Law on Local Self-Government. In many their informal connections with municipal au- cases, communalization was relatively straightfor- thorities to defend their position. ward, but the proportion ofcontested cases was also 3.27. The informality of the privatization process considerable, and uncertainty concerning title to a also offered the gmina officials unique opportuni- large number of units had a significant influence on ties for patronage and, in some cases, personal the subsequent privatization process. The disputed enrichment. In addition, local officials had a rather cases could be brought before the appropriate limited understanding of economic conditions, voivoda, whose decisions could in turn be appealed and were not inclined to disturb the existing order to a special Property Devolution Commission, unduly: although they were willing to take premises established by the Regulations Introducing the away from distant state enterprises and consumer Law on Local Self-Government and appointed by cooperatives, they were more sympathetic to the the Prime Minister. Title disputes could also be claims of the insiders employed in the local units. brought before the courts, It appears, however, that Finally, outsiders interested in acquiring newly many disputes are still unsettled. communalized property were a relatively minor 3.25. The degree of involvement of elected mu- political force in the gminas: local entrepreneurs nicipal councils apparently varied widely among pushing for open, competitive allocation were a the gminas: the councils and the municipal boards new and rather weak group, incapable of overcom- (chief executive bodies of the gminas) sometimes ing the standard popular resistance to radical changes remained entirely passive, sometimes approved the that might exacerbate the growing problems of privatization of certain types of assets and deter- unemployment. A combination of these forces and mined the method of their transfer, and sometimes factors was ultimately responsible for the predomi- intervened ad hoc in particular cases. In most cases, nance of insider-dominated arrangements, a host however, the responsibility for implementing most of restrictions on the changes that could be intro- of the privatization of communalized assets was duced in the wake of privatization, and the pre- delegated to a poorly staffed department of the local dominance of rentals over sales. administration, or, in the case of rural gminas, where the number of units was relatively small, The Extent of Gmina Privatization often to a single individual. This is not to say that higher officials in the gmina administration had no 3.28. Even prior to the legal changes, local gov- interest in the outcome of the process, but most of ernments had controlled a large amount of real the interventions of the higher officials remained estate, and privatization had been moving forward. on an informal level, which gave them more flex- General statistics on the consumer sector in 1989 ibility to use the communalized assets to their best show that slightly under 28,000 shops (out of political advantage. The process also freed a tre- slightly more than 151,000), 15,000 restaurants mendous amount of spontaneous initiative that (out of 31,000), and 214,000 service establish- was responsible for a remarkable transformation in ments (out of the total of 256,000) were already the status quo of the consumer sector. private at that time. However, the units of real 3.26. The parties most immediately and nega- estate involved in this early privatization were less tively affected were the state enterprises and con- desirable and were very small (on average, nearly sumer cooperatives. Consumer cooperatives and one-fourth the size of socialized units). In terms of state enterprises lost the allegiance of their own volume, the proportion of private retail trade to the members and employees, when the latter under- socialized sector in 1989 was still barely 5 percent. 36 Eastern European Experience with Privatization 3.29. The process ofprivatization of the real estate the gminas' preference for rentals could be that the reclaimed bythegminas through communalization gminas did not want to divest themselves of their involved the larger and more desirable units which real estate holdings at a time of relatively high in the past had constituted the core of the old inflation (and with the absence of an opportunity socialized sector. In fact, out of the total of nearly to insure against it through other forms of invest- 124,000 stores operated by state enterprises and ment). In addition, gmina officials may have per- cooperatives at the end of 1989, 31,662 were ceived an outright sale as diminishing their influence reclaimed by the municipalities and leased or sold in their communities, since their long-term control to private individuals by 1992, when the process of over real estate provided a powerful bargaining tool gmina privatization was essentially completed, ex- to use with a large number of potentially powerful cept for a handful of units, the titles to which were outsiders. still in dispute. During the same time, 19,690 out 3.33. The assets were usually not conveyed with- of41,500 state service outlets were privatized by the out additional limitations. Prohibitions on changes gminas. The process was also extremely swift: by of the line of business were added often. Among the end of 1991, 24,762 shops had already been other common restrictions were those prohibiting privatized, a figure that represents 40 percent of all sublets or resales. These restrictions may have been shops lost to private persons by the state and particularly unfortunate, given the fact that most of cooperative sectors. the units were leased to previous insiders, who, (as 3.30. Oneofthemostinterestingaspectsofgmina is shown in the survey) were much less likely to privatization is that at no point in the process did the invest in the business or otherwise restructure it. municipalities have any rights to the businesses The reasons for these restrictions may have more to operated on the premises subject to com- do with politics than economics: since the insiders munalization. The only rights acquired by the were given preferential access to the privatized municipalities were the rights to the premises them- units, their ability to sell or sublet them would have selves, and the whole process, although leading to provided hefty windfalls, which would, in turn, the privatization of the retail trade and services quickly delegitimize the whole system of insider sector, was infactdriven by a conveyance ofthe rights preferences. to real estate that devolved on the gminas. 3.31. In effect, the gminas have not really privatized The Mode of Transfer the real estate under their control, at least not in the sense of conveying full-fledged property rights in 3.34. The central government, with its preference the premises to the owners of the businesses oper- for openness and market procedures, was very ating on these premises. Instead, in the great major- much in favor of privatizing retail units through ity of cases (over 94 percent in 1990 and nearly 97 auctions. In fact, however, both our general survey percent in 1991), the gminas leased the communal- (Chapter V) and the special gmina surveyshow that ized premises, and the leaseholds conveyed to the open auctions were used in Poland in only a small new owners, according to the civil law in force in proportion of cases: in gmina privatization, the Poland, have the status of contracts rather than numberwas nogreater than 27 percent. In addition property rights valid against third parties. to open auctions, the gminas also used auctions in 3.32. Except for those cases in which the title to which only insiders (employees) could participate, the communalized property is in dispute, the gminas' or in which insiders were given special preferences, preference for leasing over sales (which tapered off usually a rebate (sometimes as large as 70 percent) only slightly in 1992) is not easy to explain. The offthe first year rental (see Table 3.3). But the most officials justified their actions by a desire to maxi- common mode of transfer was a negotiated rental mize revenues. It is possible, of course, that the or sale in which the price was most often adminis- gminas feared that liquidity problems would keep tratively determined, with insiders usually ending private individuals from paying sufficiently high up as the main beneficiaries. prices for the privatized municipal property, and 3.35. Thechoiceofnegotiateddealsoverauctions that both rents and real estate prices would be and competitive tenders resulted in marked, some- moving upward in the future. This fear, if it was times dramatic, losses of revenues from rents col- indeed a factor, was certainly unjustified, since the lected by the gminas, and also drove up the prices prices fetched by the few units that were sold were of real estate available through competitive proce- very high. A more rational economic explanation of dures. In one district of Warsaw, administratively Eastern European Experience with Privatization 37 set rents varied between ZI 5,000 and ZI 25,000 per by tenants and even owners of the premises "priva- m', while competitive pricing brought rents of up tized" by the gminas. While results of the CEU to ZI 1,560,000. In other areas the differences were study of gminas are incomplete on this point, they less dramatic, but still enormous. In one sense, the show that 50 percent of the gminas that acquired low prices clearly reflected special terms offered to units through communalization had by March insiders, but evidence for a more economic justifi- 1993 renegotiated transactions involving 15 per- cation of this practice is ambiguous. cent of all privatized units. The conclusion to be 3.36. Auctions conducted in the absence of a drawn is that the usual term of the leases entered reliable market for similar units are apt to produce into by the gminas is very short: assuming that the relatively high rates of overbidding errors. During average lease was entered into no longer than two the pre-reform period, a shop ofany kind produced years prior to the study, a significant percentage of extraordinary returns owing to the simple phenom- leases must be for a period of less than two years. enon of shortage. Thus, at least in the early period The short terms of these leases, especially when of reforms, prospective buyers and tenants were apt considered with the gminas' tendency to treat to overestimate the value of the real estate for which rented premises as still under their "control" (and they were bidding, especially in less desirable loca- to look to them as sources of higher revenues in the rions. This could. in turn result in early business future), are likely to make tenants insecure and to failure. Some evidences of such "overbidding," and have adverse effects on investment and restructur- the resulting business failures have been found. ing. 3.37. In any case, the number of units which had 3.39. As is evident, then, the primary beneficiaries to be reclaimed by the gminas as a result of non- of gmina privatization were the former employees payment of rental fees was not very large: in the of consumer cooperatives and state enterprises who CEU survey of gminas it amounted to 5.8 percent managed to convert their status into ownership. of the privatized units. Although it is impossible to While available information does not permit an break down the failure figures by mode of transfer estimation of the percentage of the communalized employed (auction or negotiated deals), there is units that came under the control of their former substantial evidence that the greatest number of employees, indirect data are in accord with the failures occurred among insiders, most of whom general belief in insiders' dominance. Outsiders obtained their property through negotiated rentals. were explicitly excluded from 2 percent of all Also, while the expected failure rate (the number of transfers, and had to contend with auctions which times the gmina had to reclaim property) among included insider preferences in another 10 percent. gminas where negotiated rentals "typically" re- The ability of outsiders to compete in direct nego- sulted in outsider-dominated establishments was tiations, through which the largest proportion of 2.5 units, the same rate jumped to 5.4 units when units (61 percent) were transferred, is not known, the "typical" situation involved insider-dominated but the outcome was heavily slanted toward insid- units. ers: in 74 percent of gminas in which direct nego- 3.38. An interesting feature related to the mode of tiations were used, insiders were said to be the transfer is the degree of security of tenure enjoyed "typical" negotiating partners. Table 3.3: Poland: Methods of Transferring Commercial Premises by Gminas Method of Transfer Percentage of Units Privatized by Method Direct Negotiation 61 Insider Auction 2 Auction with Preferences for Insiders 10 Open Auction 27 Source: CEU Gmina Study. 38 Eastern European Experience with Privatization D. Privatization by Housing Cooperatives justified, in light of their need to assure that certain types of services were provided to their tenants. The The Role of Housing Cooperatives strong incentive of housing cooperatives to maxi- mize rental income from their commercial proper- 3.40. After the municipalities, housing coopera- ties was responsible for the fact that auctions were tives had been the main real estate owners before apparently used more often by the cooperatives 1989, and they played a correspondingly impor- than by the gminas, but no precise data are available tant role in the transfer of the use ofcommercial real on the proportion ofunits sold or leased in this way. estate into private hands, which constituted the There is also evidence that cooperative rentals were, essence of Polish small privatization . As we have on the average, significantly higher than those seen, housing cooperatives had not been formally entered into by the municipalities. But direct nego- subject to the Housing Act of 1974, and thus the tiations also played an important role in the alloca- effective causes ofthe change in their rental policies tion of commercial premises by housing were due not to the Housing Act Amendments of cooperatives, probably chiefly because of an inter- 1990 but rather to the dissolution of the coopera- est in maintaining certain types of stores in coop- tive associations and other changes related to the erative housing complexes. Housing cooperatives enactment of the 1990 Law Governing Changes in were also less likely than gminas to impose burden- the Organization andActivities ofCooperatives. Also, some restrictions on their tenants, but, to preserve the structure ofincentives for the housing cooperative certain types ofservices for residents, restrictions on officials differed considerably from that for the repre- changing the line of business between lease terms sentatives of the municipalities; consequently, the were relatively common. course of privatization controlled by the coopera- tives was different from that of gmina privatization. E. Privatization of Units Owned by State 3.41. Unlike the municipal officials, who had to Enterprises balance a greater variety of conflicting interests, the local housing cooperative officials, with their new 3.44. The preceding sections have described the degree of independence, could be more responsive mortal blow given to most state enterprises by the to the needs of their members/residents. Housing 1990 Housing Act Amendments and the changes cooperative officials thus most often pursued a in the cooperative regime. In 1989, state enterprises rental policy dictated by the twofold interests of in the trade sector ran approximately 36,000 retail their membership. First and foremost, the mem- outlets, ofwhich 27,000 were stores. Ofthe 27,000 bers wanted to maximize revenues from the rental stores, approximately 15,000 to 17,000 were lost to of commercial space so as to subsidize the residen- communalization and housing cooperatives. But tial tenants (especially in the wake of the with- the loss of units did not lead to the immediate death drawal of state subsidies, which formerly covered of state retail trade enterprises. Some of these over 30 percent of the costs). Second, they wanted enterprises had constructed and owned stores in to maintain certain types of stores in their housing areas in which commercial space in housing coop- complexes, especially when there were few other eratives or government-owned buildings was un- shopping areas in the vicinity, available, and a certain number of their stores were 3.42. Like gmina privatization, small privatiza- located on premises owned by the central govern- tion by housing cooperatives was an amalgamation ment, which the state enterprises had been able to of many unregulated and unmonitored processes. keep in the wake of the onslaught by the other real- Consequently, housing cooperative privatizations estate owners. These enterprises were thus left with were largely unrecorded. A very rough estimate of some 10,000 to 12,000 stores, and the reform of the number of units privatized by housing coopera- the old pseudo-cooperative system added some tives is about 12,000. 2,300 new units to the state sector.10 In addition, state enterprises were left with a large amount of The Type of Interest Conveyed and the Process of warehousing space, their old distribution systems, Allocation and an extensive and costly central bureaucracy of the former large corporate structures, and the priva- 3.43. Housing cooperatives, like gminas, over- tization of these assets is the subject of this section. whelmingly favored rentals over sales of their com- 3.45. State enterprises managed to privatize some mercial properties, but their preference seems more 3,000 to 5,000 stores throughout this period, not Eastern European Experience with Privatization 39 an impressive Figure, even considering the fact that tion to requiring the consent of the employee the stores lost to communalization and housing council, Article 37 liquidations also permit a leas- cooperatives were the more attractive ones. How- ing of the enterprise assets (and not just their sale), ever, since most state enterprises are in the process which makes the whole process much more attrac- of liquidation, in the course of which often an tive to the employees.12 A liquidation plan under entire business is privatized in one fell swoop, a Article 37 is worked out between the enterprise and large number of the remaining units may be trans- the founding organ (usually, in the case of trade ferred to private hands in the near future. enterprises, the local voivoda or the mayor ofa large 3.46. Privatization ofstate enterprises in the retail city), with the Ministry of Privatization having trade sector has occurred primarily through the so- only a supervisory function. It is perhaps a measure called "liquidation" method, and, after that, through of the spontaneity of the Polish small privatization the leasing of individual units to third parties (often that this most decentralized form of formal priva- employees) by particular enterprises. In a few cases, tization under Polish law is the most bureaucratic for example those of large department stores or and cumbersome method of privatizing retail stores specialty shop chains, state enterprises were ex- and catering and service establishments. pected to be converted into joint-stock companies, 3.49. Prior to liquidation, the central state enter- and privatization would be scheduled to follow prise or association would be dissolved and the through a sale of shares to foreign or domestic responsibility for the regional branches would de- investors." Very little information is available on volve on local officials, who would assume the role these "capital privatizations" (as they are known in of founder.3 The actual process of liquidation Poland), but apparently, with the exception of a would be as follows: the founders would install a small number of partial acquisitions or joint ven- new director (or a liquidator in case of insolvency) tures, not much has taken place as yet. More whose main task would be to restructure the enter- information has been obtained about the process of prise and prepare it for privatization. The voivoda liquidation. would supervise the process and assist in the priva- 3.47. "Liquidation" is a term that refers to two tization through training and other means. Prior to separate processes under Polish law. First, enter- preparing a privatization plan, two essential prob- prises that are insolvent may be liquidated under lems would need to be addressed. First, many of the Article 19 of the 1981 Law on State Enterprises, stores that were lost through the communalization which specifies a bankruptcy procedure for state process and to housing cooperatives had invento- firms. With these liquidations, the assets of the ries of goods and equipment that had been appro- bankrupt company are either sold or contributed priated by employees. Pursuing and resolving these by the state to a successor company, such as a joint claims would be an important function. Second, venture or a similar arrangement. The most impor- the high level of overstaffing would need to be tant fact about the insolvency liquidations is that reduced. they do not require the consent of the employee 3.50. Finally, a privatization program would be councils, which are a powerful force in many Polish prepared. A portion of the assets would usually be state enterprises, and thus fewer concessions to the sold off to outsiders in order to improve liquidity insiders are necessary. In practice, however, even and pay off the debts of the enterprise, while the though the sale of assets is supposed to be public, remainder would be scheduled for an employee the assets are most often acquired by the enterprise buyout or a leasing program. In some cases, all or insiders, who receive preferential terms and subsi- most of the units would be kept together and the dized loans. enterprise assets would be sold or leased as a whole 3.48. In addition to insolvency liquidations, state to a successor employee-owned company. In other enterprises may be subject to another form of cases, individual shops would be privatized indi- liquidation, governed by Article 37 of the 1990 vidually (usually sold or leased to the employees), Law on Privatization of State-Owned Enterprises. with only a few assets remaining to be liquidated. To qualify for this process, enterprises must be The law requires that all sales of assets of liquidated solvent, and the "liquidation" is in fact a form of enterprises be public but the property need not go privatization, in which the assets of the enterprise to the highest bidder, and other criteria (including are sold or leased to a new company, formed insider status) may be decisive. As a result, public especially for this purpose by the employees, often participation is often minimal or nonexistent, and, with the participation of outside investors. In addi- in most cases in which sales actually took place, they 40 Eastern European Experience with Privatization resulted from negotiations with the employees. the state) was thus clearly a fundamental impedi- The assets to be sold must usually be evaluated by ment to the creation of an efficient consumer a local consulting firm or the liquidator himself, sector. The first post-communist government un- but in the cases studied for this report, the actual dertook to reform the cooperatives and destroy sale price was no more than one-third of the origi- their monolithic organization. The outcome of this nal valuation. effort was theJanuary 1990 Law Governing Changes in the Organization and Activities of Cooperatives F. Restructuring and Privatization of the Polish (the "Cooperative Restructuring Law"), which dis- Consumer Cooperatives solved the central cooperative bodies and other cooperative associations, and mandated a transfer 3.51. Prior to 1989, consumer cooperatives were of their assets to new owners. Paradoxically, how- the largest owners and operators of retail and cater- ever, the Cooperative Restructuring Law was never ing establishments in Poland. Cooperatives ran followed by the planned more comprehensive re- approximately 96,000 stores (64 percent of the form of the cooperative movement, so that local total and 77 percent of the socialized sector) and cooperatives in Poland, unlike their Czech and 44,000 other outlets. In addition, they operated Hungarian counterparts, are still governed by out- over 13,000 thousand restaurants and other cater- dated communist legislation, dating back to 1982. ing establishments (42 percent of the total and 81 3.54. The restructuring and privatization of the percent of the socialized sector), and they accounted consumer cooperative movement in Poland in- for 13 percent of the sales of services. volved four different processes. First, the Coopera- tive Restructuring Law attacked the cooperative The Liquidation of Cooperative Associations associations directly, privatized a significant por- tion of their property (which did not include many 3.52. Under the old regime, cooperatives were retail units, but had a very significant impact on the organized in a hierarchical series ofassociations. All wholesale and distribution systems), and released local consumer cooperatives of a particular organi- individual cooperatives from centralized control. zation (including two giants in the retail sector, Second, the cooperative system lost units as a result Spolem, and Samopomoc Chlopska, as well as of the 1990 Housing Act Amendments and the smaller specialized organizations) were grouped restructuring of housing cooperatives, with effects together in regional associations, which were in similar to those for state enterprises. Third, local turn linked with other regional associations in cooperatives, cut from the tutelage of the associa- nationwide unions. The upstream organizations tions and the subsidies channeled through them by were organs of the command system of distribu- the state, and weakened by the loss of units through tion. They had control over purchasing centers, communalization and other claims to the premises wholesale units, and transportation networks. They on which many of their best units had been operat- held financial assets, maintained relationships with ing, started selling or leasing their stores and restau- the banking system, received obligatory payments rants to private parties, most often to their own to their "development funds" from local coopera- members and employees, but sometimes also to tives, and decided upon the distribution of monies small outside entrepreneurs. Fourth, local coopera- from that fund. The local cooperatives had no tives themselves were privatized, in part through a choice of suppliers and no control over their own stroke ofa bureaucrat's pen, since they were reclas- expansion, and the overwhelming proportion of sified as "private" and ceased to be considered a part their revenues was siphoned off by the upstream of the "socialized" sector, but in part also because organizations (disbursements to members were they ceased to be state controlled and, at least to usually in the neighborhood of 3 percent of the some extent, restructured their operations. profits). Not uncommonly, local cooperatives had 3.55. The Cooperative Restructuring Law placed been forced to transfer to the association a portion all cooperative associations into immediate receiv- of their own assets, such as a plant or another ership, to be followed by liquidation proceedings. enterprise, that the association was interested in The liquidators were responsible for developing operating directly. plans for the disposition of all assets of the associa- 3.53. The cooperative, or rather pseudo-coopera- tions, and managing them in the transitional pe- tive, system (since the cooperatives were tightly riod. A liquidation plan would then be presented controlled by central organizations dominated by for the approval of the representatives of the local Eastern European Evperience with Privatization 41 cooperative members of the association, with the 3.58. The Cooperative Restructuring Law also Ministry of Finance and its representatives reserv- created a new cooperative association, the Supreme ing the right to approve it if the membership failed Council of Cooperatives, to serve as the domestic to act within a 30-day period. and international representative of the sector, but 3.56. The first point of a liquidation plan was to membership in the Council is purely voluntary. exclude from the assets of the association any plants The remaining cooperatives are also allowed to or other assets which had been transferred to the form other types of voluntary associations, and it is association without payment from local coopera- perhaps a measure of their difficulty in "going it tives during the preceding ten years. All assets of alone" that the growth of such organizations has this kind were to be returned to their original beenveryrapid.Thus,forexample,shortlyafterthe owners. Financial assets of the association, such as beginning of the liquidation process, some 200 working capital and reserves held in development local cooperatives from Samopomoc Chlopska funds, were to be used to repay the liabilities of the formed an "economic chamber." As of the end of association and defray the costs of the liquidation. 1992, membership in the chamber had grown to With respect to the remaining assets, the Coopera- 1,670 cooperatives. tive Restructuring Law provided for the following methods of disposition. Privatization ofand by Local Cooperatives * Assets could be transferred to member coopera- 359 The abolition of cooperative ociations tives, with or without payment. Usually, no had two significant consequences for the Polish payment would be required if a local cooperative trade and service sector. First, the sale of the prop- took over a business previously run by the associa- . tion together with its liabilities. If the association pattern of ownership over warehouses and other paid the liabilities associated with the transferred maso trg n rdc itiuin h busiesstherecivi cooratve oul bemeans of storage and product distribution. The g c resulting diversity of potential supply sources was quired to make a partial or total payment. essential to the genesis of competition and market * Another group of preferential recipients were behavior. Second, and perhaps more important, the employees of the business associated with the breakup of the associations changed the coop- the transferred asset. For this purpose, at least erative sector from one characterized by hyper- half of the employees had to found their own centralization into one in which individual cooperative and capitalize it at an appropriate cooperatives were forced to fend for themselves. level (at least three months ' salary from each Placed in the unfamiliar position of having to member), and the asset might then be trans- manage their own financial resources and make ferred to them without payment. their own business decisions, cut off from their * Assets not transferred to local member coopera- previous sources of ready credit and subsidization, tives or the employees could be sold at auctions individual cooperatives often found themselves open to the public. forced to sell or lease their units in order to maintain even a semblance of stability. As a result, a large * Subsequent amendments to the law allowed for number of retails stores, restaurants, and service assets to be transferred to joint-stock or limited- units were transferred to private hands, and the liability companies established by former work- remaining cooperatives themselves were often trans- ers or cooperative members. formed into more independent, business-oriented 3.57. The mechanics of the Cooperative Law organizations. ensured that the distribution of assets would be 3.60. The Cooperative Restructuring Law re- determined primarily by negotiations among the quired that cooperatives hold new elections within liquidators, employees, and local cooperative offi- less than three months from the passage of the law cials. Outside investors seem to have played a minor or face liquidation. Because of the short time span, role, but they may have been involved behind the however, new forces were unable to organize, and, scenes in a number of cases. Despite the law's only an estimated 15 percent of elected officials unambiguous mandate, fewassetswere sold through were new entrants, with the rest representing the truly open auctions. (Apparently, despite their old cooperative nomenklatura. The Cooperative dubious legality, closed auctions, by invitation of Restructuring Law also provided that each discrete the liquidator, were rather common.) organizational unit of an existing cooperative, or a 42 Eastern European Experience with Privatizaton unit that might become organizationally indepen- manner they selected, and to attach any number of dent, had a right, to separate from the rest of the conditions to their subsequent operation. In gen- organization. But there appeared to have been little eral, cooperatives have favored leases over sales, and interest, and only 100 new consumer cooperatives have offered the first choice ofrental to the employ- were created within the first two years df the enact- ees of the privatized unit. The reasons why con- ment of the law." sumer cooperatives favor leasing over sales (and the 3.61. The only other legal change in the structure rentals are usually of fairly short duration)" appear of the Polish cooperatives was brought about by the not to be related to revenue maximization and may 1991 Law on Valorization of Members' Shares in be linked to a belief in the future development of Cooperatives, which allowed cooperatives to in- the cooperative retail sector. Interviews with coop- crease the value of each individual member's share, erative managers indicate a certain assurance among at the expense of the financial assets held in the them that the financial conditions of cooperatives indivisible common fund. While this change made will improve. Retention of ownership control over the concept of cooperative membership somewhat property may thus be viewed as an important factor more meaningful than before, the law also imposed a for future growth and diversification. On the basis five-year restriction on cooperative asset alienation, of the limited available data, it appears that leases which made exit more difficult and decreased the regularly contain restrictive provisions, mostly con- likelihood that cooperatives would be dissolved or cerning changes in the line of business. These are transformed into other types of business entities. more common in rural areas, where such restric- 3.62. Again, privatization by local cooperatives, tions may make sense (but may also be the result of like most forms of small privatization in Poland, less competition among owners of real estate). has been an extremely decentralized and diversified There was also a detectable desire on the part of a phenomenon, and it is difficult to come up with number of cooperatives to ensure that lessors do reliable numbers concerning its results. On the not compete with the stores retained by the coopera- basis of deductive calculation, it is estimated that tive or leased to other individuals. Protection of coop- through the end of 1992 the number of stores erative supply systems may also have played a role. operated by consumer cooperatives had declined 3.64. The unwillingness of cooperatives to cede by approximately 51,000 units subject to some ownership or true operational control over their form of privatization. Of these, approximately units, taken together with their attempts to recreate 27,000 to 29,000, or 53 to 57 percent, were lost to nationwide networks of cooperative associations, communalization and housing cooperatives through could indicate that the transfer of previously coop- the mechanisms described earlier. We are thus left erative units to genuinely private hands may be a with a balance of 20,000 to 22,000 shops, which reversible phenomenon. It remains to be seen represents a fair estimate of the number of units whether the cooperatives will reestablish them- privatized by consumer cooperatives themselves. selves as a united force in the domestic trade sector, 3.63. Unhampered by any legal regulations, co- and what effect their new organization will have on operatives were free to privatize their units in any the state of the competition in the retail market. Notes 5. GUS Statistical Yearbooks 1989-92, Institute of Internal Market. 1. The government's liberal stance on foreign trade was a 6. GUS Statistical Yearbook. major factor in the growth and expanded assortment of 7. The restrictions did not apply to privately built shops and consumer goods. Between 1989 and 1992, consumer workshops if they were used according to their designated imports, as a percentof total imports, grew from 12 to over purpose by the owner or his family, or to buildings owned 34 percent. by socialized enterprises. 2. Voivodships are the largest territorial units of the Polish 8. Once it had been assigned, the use of the premises was government. There are 49 voivodships, each headed by a rarely changed. prefect, or voivoda. 9. A fairly large number of gminas in our study (34) did nor 3. This result is confirmed by the Survey in Chapter V. obtain any units through communalization. If these are 4. The apparently very high number of private units in 1989 left out, the percentage ofgminas without a plan falls to 81 tends to exaggerate the private sector's share of trade at that percent. time. Most private units were small stands, booths, and 10. The reform of the cooperative network of over 20,000 service workshops set up within months of the enactment kiosks and some 2,300 stores, selling newspapers, ciga- of the Law on Economic Activity on January 1, 1989. rettes, and a variety of other goods, led to the establish- Eastern European Experience with Privatization 43 mentofanewstate-ownedjoint-stockcompany, "Ruch," tative of the state, it also plays an important role in which became a part of the state sector. enterprise privatization. 11. The largest joint-stock company of this type is the "Ruch" 14. Separation was more common among housing coopera- chain, with a near monopoly on the distribution and sale tives, which served much better defined constituen- of newspapers, periodicals, cigarettes, and a number of cies. convenience items. 15. Case studies commissioned by the Privatization Project 12. The leasing involved is actually a form of installment sale, showed that leases with determinate time periods ranged with the title passing at the end of the lease term. The terms from one to three years. Cooperatives also showed a are also advantageous because the interest rate on the sale propensity to conclude leases of indeterminate length is in practice negative. which, under laws operative in Poland, allows for a termi- 13. The founder organ, under the Law on State Enterprises, nation of the lease by either party with 30 days' notice. has a multitude of rights and responsibilities concerning Such behavior may prove to create significant disincen- the running of a state enterprise. As the formal represen- tives for leaseholders to invest in their business. * Chapter Four Hungary A. Introduction mise of the communist regime are placed in a broad historical context. In essence, the situation in Hun- 4.1. The Hungarian approach to the privatiza- gary differed from that in Poland and the Czech tion of the trade and service sector has differed Republic because of Hungary's legacy of years of considerably from the approaches adopted in Po- reforms that had preceded the change of regime. land and the Czech Republic. While the latter two The Hungarian retail and service sector, in particu- countries attempted above all to remove the state as lar, had experienced a series of reforms dating back rapidly as possible from the running of their shops to the late 1960s, when the so-called New Eco- and restaurants, the primary objectives of the Hun- nomic Mechanism (NEM) changed the relations garian authorities were far more complex. In addi- between enterprise managers and government offi- tion to the goal of de-statization, Hungary's cials, as well as between enterprise managers and approach might be characterized as focusing on the managers of individual stores and restaurants. three important objectives: (1) to create a market 4.4. Under the NEM, the locus of most eco- structure similar to that in Western economies; (2) nomic decision-making shifted from the ministries to raise revenues to finance the state budget deficit; to individual enterprise managers. Enterprise man- and (3) to assert effective governmental control agers were gradually given control over such deci- over the process of privatization itself. sions as the line of business of individual stores, 4.2. To these ends, Hungarian officials have their supply arrangements, the internal organiza- made use of a number of privatization strategies, tion of enterprises, and ultimately the pricing of and the privatization of individual shops, as op- the goods sold in state shops. The devolution of posed to large state trade organizations, has been real authority onto enterprise management culmi- considered appropriate only for a portion of the nated, in 1988, with the "Company Law"' which sector. The majority of state assets in trade and allowed managers to divide their enterprises and services have been, or are about to be, privatized in spin off diverse subsidiaries without obtaining ways that emphasize the transfer of many units ministerial approval. Trade enterprise managers together, grouped to form integrated commercial then attempted to create new commercial compa- entities. "Small privatization," as this term is nor- nies, which were removed from state oversight. mally used, is thus in no way synonymous in the Exploiting lax controls over the movement of state Hungarian context with the privatization of the property, some of these managers, through a pro- entire trade and service sector. cess known as "spontaneous privatization," trans- 4.3. Why have the Hungarian officials elected to ferred prime state assets to themselves or to their pursue privatization strategies so markedly differ- foreign and domestic business partners. These im- ent from those of neighboring Poland and the provisational privatizations in the trade sector in- Czech Republic? The Hungarian policies can be cited some of the largest scandals of the last years of better understood if the events following the de- the communist regime. 46 Eastern European Erperience with Privatization 4.5. Other reforms, begun in 1968, affected the measure of competition and efficiency into the relations between enterprises and managers ofindi- provision of consumergoods and services unknown vidual state stores. At first, profit incentives were in the other countries included in this study. introduced into the pay packages ofshop managers. Hungary's early reforms bequeathed to the demo- Theseprofit-sharingarrangementswerethengradu- cratic government elected in 1990 a trade sector ally expanded during the next two decades, as many that bore scant resemblance to those in Poland and shops were leased to the employees and other Czechoslovakia. parties and as shop managers acquired increasing 4.8. It was the superior performance ofthe Hun- autonomy in running their units. As a result, a garian trade sector that accounts for the very differ- growing number of decisions concerning the op- ent Hungarian approach to privatization after the eration of the sector were made not in accordance end of the old regime. To begin with, in Hungary with the dictates of remote planners, but by store the importance of the immediate privatization of and enterprise managers on the basis of profitabil- most shops and restaurants was less evident than in, ity and consumer demand. for example, Poland, since the population was fairly 4.6. Consumer cooperatives, the other half of well served by the existing system. In addition, in the socialized trade sector, were also affected by the Hungary, privatization under the old regime had general movement away from centralized control. been regarded with some distrust owing to its Between 1969 and 1971, a series of laws freed "spontaneous" version, and calls to curtail its abuses consumer cooperatives from many restrictions that initially drowned out the demand (so strong in had previously prevented them from operating Czechoslovakia and Poland) for further ownership stores in urban areas and had interfered with their reforms. business decisions. The role of the National Federa- 4.9. The government's need for money to ser- tion of Cooperatives in running the daily opera- vice Hungary's large foreign debt increased its tions of cooperative stores was reduced and, as in incentive to exert control over privatization. Since the state sector, profit-sharing and other contrac- the trade sector was identified as a particularly tual arrangements became common. attractive area for foreign investment, halting its 4.7. Perhaps most important, the reforms of the spontaneous privatization was of special interest to last two decades of the communist regime ended the new government, the socialized sector's monopoly in trade and cater- 4.10. While the reassertion of control over state ing. Although private entrepreneurs were restricted property slowed the progress of privatization, the by various limitations on the size of their busi- desire to assure that the proceeds from privatization nesses, access to foreign markets, and the opportu- would be available for the state budget served as an nity to limit personal liability for losses, the state incentive for the formation of a privatization plan. permitted and even encouraged a variety of private The need to act quickly, at least with respect to the economic entities. Legislation concerning private trade sector, was also underscored by the numerous economic activity became increasingly liberal and calls, heard during the first post-communist elec- resulted in the very rapid growth of the new private tion campaign, for the restitution of private prop- sector. By the late 1980s, all segments ofHungarian erty nationalized during the old regime. The fear retail trade and services included a sizable private that restitution might interfere with the component. The state still retained its monopoly government's objective of raising revenues from on wholesale trade, severely restricting the range of privatization gave added priority to setting a priva- products offered to consumers. Regional enter- tization strategy for the trade sector. prises still operated extensive networks ofshops and 4.11. The opposition of the sectoral insiders to a dominated the market in urban areas, while rural centralized privatization strategy and the state's trade was the all but exclusive domain of large desire to circumvent this opposition without a consumer cooperatives. The maze of regulations major confrontation provide the principal explana- and restrictions was responsible for an unusual tion for the further course of events. ownership and control structure of the sector, with 4.12. In September 1990, the government an- state enterprises being able to derive substantial nounced its "Preprivatization" Program, which profits through subleasing their state stores to pri- was designed both to assert governmental control vate parties. But combined with macroeconomic over the privatization process and to spawn a stream changes, such as price liberalization and the growth of revenues for the state. Preprivatization was a of foreign trade, the new system introduced a centralized program to be run by the newly estab- Eastern European Experience with Privatization 47 lished State Property Agency (SPA), aimed at sell- 4.15. In all of its programs after Preprivatization, ing, at public auctions, the state's rights to a part of the SPA has focused on the privatization of entire its shops, restaurants, and service outlets. But enterprises rather than individual shops and restau- Preprivarization was also designed to avoid exces- rants. This move away from the usual model of sive confrontation with the managers of the sectoral small privatization has been predicated on the state enterprises, and for this reason the program desire to shape the post-privatization trade sector in did not apply to all state assets in the sector. Instead, Hungary in the image of the commercial sector in the primary targets were those shops and restau- the West, with its emphasis on companies that rants that had been leased to private entrepreneurs integrate wholesale activities with large chains of and were thus the least integrated into the function- retail or service outlets. This approach, called "in- ing of state enterprises. In all, the program applied sider" or "technocratic" in our earlier discussion of to no more than 30 percent of the state establish- Czech privatization, gained much greater accep- ments (between 10,000 and 15,000 units). tance in Hungary than in the Czech Republic or 4.13. SPA strategies for dealing with the portion Poland. of the commercial sector not affected by 4.16. In the Czech Republic, as has been pointed Preprivatization were slow to develop and slower to out earlier, the proposals for keeping the organiza- be implemented. The programs that followed in- tional structure of state enterprises intact were cluded the First Privatization Program and Self- defeated by the public hostility to sectoral insiders, Privatization, both of which had a broader scope the enactment of restitution legislation, and the and included a range of enterprises outside the ideological opposition of the Ministry of Privatiza- trade and service sector. Both of these programs tion. In Poland, the technocratic approach to priva- have encountered problems and succeeded in priva- tization of the trade sector was decisively rejected tizing only a small number of enterprises. In addi- from the very beginning: since the endemic short- tion to these major efforts, the SPA has either ages of most goods were taken as proof of the announced, or is in the process of preparing, other, bankruptcy of the old system, the idea of preserving more limited privatization schemes designed spe- the structure of the state enterprises had no appeal. cifically for certain portions of the commercial In Hungary, in contrast, reforms under the old sector, such as pharmacies, or new chains carved system, while far from perfect, did provide a sub- out of units presently belonging to various state stantial improvement in the availability of con- enterprises. The government has had only limited sumer goods and services, and thus the managers in involvement in the changes that have altered the state trade enterprises could claim a measure of role of the consumer cooperatives, a process that social approval. The hostility to sectoral insiders has occurred with only minimal property transfers. was also lessened in Hungary by the more prag- matic nature of the old regime. Finally, the finan- The Role of the SPA cial needs of the state further spurred the adoption of a technocratic strategy, since government offi- 4.14. Despite the large number of privatization cials assumed that sales of trade enterprises with programs in Hungary, a consistent and persisting large networks of shops would be more lucrative strategy of the SPA can be discerned. In every and, unlike individual stores, would attract foreign program since Preprivatization, the SPA has been investors. active in selecting the enterprises and units to be 4.17. There may also have been a degree of con- included and has been involved in the elaboration viction that Western models were more appropri- ofdetailed privatization and post-privatization plans ate for Hungary than was the anti-statist approach for the new firms. While the SPA's role was most of the Czech Republic or Poland. A large propor- visible in the First Privatization Program, its influ- tion of the SPA staff was in fact drawn from the ence in Self-Privatization has also been pervasive. former branch ministries and selected for its exper- The SPA has retained control over entry into the tise in restructuring state enterprises. These offi- program and all essential decisions along the way. cials were perhaps predisposed to support Plans for the privatization of new chains in the retail technocratic privatization strategies that called for sector are similarly based on the SPA's choice of the their particular skills. sub-sectors and enterprises involved, as well as of 4.18. The accomplishments of these technocratic the detailed mechanics of the process. programs have been disappointing. The failures of 48 Eastern European Experience with Privatization the First Privatization Program pointed up the While, on the surface, therefore, Hungarian priva- weaknesses of "over-engineered" solutions. The tization programs have followed the technocratic Self- Privatization program has been more success- models, their actual outcomes have often differed ful in privatizing a number of small service firms, significantly from what was planned, and fewer but has not achieved notable success with respect to enterprises than expected have been sold as a whole. larger trade enterprises. The SPA's efforts to priva- tize the remaining parts of the state sector have also Quantitative Evidence of the Transformation been stalled by debates over which technocratic model to follow. 4.20. Between 1988 and 1992 the total number 4.19. The SPA's difficulty in devising smoothly of active establishments in the Hungarian trade functioning privatization mechanisms has given sector nearly doubled (Table 4.1). This growth has rise to a peculiar internal dynamic common to been spearheaded by an almost 300 percent in- many Hungarian privatization programs. Faced crease in the number of private units, which com- with the clogged central mechanisms for privatiza- prise new entrants and privatized state and tion, enterprise insiders, as well as outside investors cooperative units. eager to purchase the remaining state units, have 4.21. The extent of privatization can only be attempted to find alternative avenues of ownership approximated. Of the 12,000 units that disap- transformation. This pressure has led to a situation peared from the state sector between 1988 and in which each program has ended up with its own 1992, it is estimated that the majority (about unintended privatization mechanisms, many of 10,000) have been privatized. The remainder which allow the interested parties to detach indi- simply changed their organizational form: instead vidual units from their enterprises. It appears likely, of being parts of state enterprises, these units be- for example, that fewer than one-half of the units came incorporated in new and still largely state- ultimately privatized under Self-Privatization will owned joint stock companies.' be privatized as part ofan entire enterprise, and that 4.22. While the rate of small privatization has ways have been found to circumvent the competi- been slower in Hungary than in Poland and the tive procedures designated as "exclusive" in the Czech Republic, the growth of the new private program. The majority of units appear destined to sector has been very impressive. By the end of 1992, be transferred individually, through liquidation units operated by private dealers and incorporated sales or other unpredicted transfer procedures. companies (many of which are private) accounted Table 4.1: Hungary: Change in Affiliation of Units in the Retail and Catering Sector from 1988 to 1992' 1988 1990 1992 State Enterprises 26,366 17,410 14,000 Incorporated Companies' 671 6,240 30,000 Cooperatives 27,349 22,323 18,000 Private Dealers 34,541 60,141 102,755 Total 88,927 106,114 164,755 There is some disagreement concerning the number of private shops and catering establishments at the end of 1992, with estimates ranging as high as 200,000. 2 Incorporated companies include limited partnerships, limited liability companies, and joint stock companies. Sources: Hungarian Statistical Yearbook and Erzsdbet Gem, 'Private Enterprises in Retail Trade," unpublished manuscript,1993;Central Statistical Office, unpublished data. Eastern European Experience with Privatization 49 for almost 80 percent of the Hungarian stores and Pre-1988 Reforms restaurants. While their share of the turnover is less impressive than the number of units, the official 4.26. Within the firms classified as belonging to turnover figures (50 percent) almost certainly un- the state sector, there existed, prior to 1988, a derestimate the new private sector's share of the variety of arrangements with varying degrees of market (which may be as high as 70 percent). market incentives and private participation. These 4.23. However, the stores originally controlled by reforms had, by the end of the 1980s, already the state were, by and large, among the most altered the operation of the sector. Two distinct productive units, situated in the most desirable categories mark these reforms: the reform of state locations. Ownership control over these stores is enterprises, and the creation of private business thus at the heart of the ultimate transformation of opportunities. the Hungarian consumer sector, and for this reason the unfinished nature of Hungarian small privati- Reform ofState Enterprises zation remains important. 4.27. Until 1968, state enterprises were centrally B. Pre-1990 Reforms controlled by branch ministries. The Ministry of Domestic Trade (reorganized as the Ministry of History Industry and Trade in 1990) oversaw the activity of state enterprises organized by product line and by 4.24. Hungarian economic reforms prior to 1990 region. In each of the country's regions, one state introduced important structural and functional enterprise held a monopoly concerning a particular changes in the trade and service sector. Deregula- line of activity. Each enterprise supervised a num- tion, distribution of decision-making authority ber of retail units, setting targets for sales and wages among sectoral participants, and the encourage- and allocation of inputs. Wholesale supply was ment of small establishments were the hallmarks of organized along a parallel structure, with enter- these policy changes. It is useful to divide these prises purchasing supplies from designated regional reforms into two periods: (1) those undertaken suppliers. Inter-regional or ad hoc supply relation- prior to 1988; and (2) those initiated between 1988 ships were forbidden. and 1990. Free elections in 1990 announced the end 4.28. A degree of flexibility was introduced in of this first period ofHungarian trade transformation. 1968 with the NEM program. Fundamental re- 4.25. Despite our focus on property reforms, price gional organization structures were left unchanged, setting reforms and the structure of foreign and but decision-making authority was shifted over wholesale trade were also of great importance in the time from branch ministries to the enterprise level. evolution of the Hungarian trade sector. Experi- Obligatory input and output quotas were abolished ments in freeing prices began in the 1960s. By in 1968, and scope for genuine profit-and-loss 1988, between 60 and 70 percent of retail prices calculations in state enterprises was expanded. were freely set and price adjustments were often Wholesale enterprises were permitted to engage in linked to the convertible currency prices for goods cross-regional trading, and retail trade enterprises traded on foreign markets. Reliance on market could buy directly from producing enterprises. mechanisms decreased arbitrage opportunities for 4.29. Further reforms in 1977 and 1984 gave private individuals seeking to exploit the difference considerable autonomy to enterprises by establish- between official and black market prices, probably ing "Enterprise Councils," a majority of whose discouraging the most blatant forms of parasitic members were elected by workers and employees. private economic activity. At the same time, legiti- The responsibilities of the Councils included elec- mate private enterprise was encouraged by the tion of the enterprise director, determination of freedom to price goods according to market re- changes in the line of the firm's activity, and sponses. However, while price liberalization en- organizational changes in the enterprise. Direct couraged the creation of private commercial state oversight of enterprise activities was retained establishments, the unwillingness of governmental in only roughly one-third of the enterprises which authorities to allow private entrepreneurs into were classified as of strategic importance. State wholesale and foreign trade affected the develop- managers were given a wider degree of freedom to mentofprivatetradeestablishments.Thestaterelaxed operate and restructure their self-managed enter- its monopoly on foreign trade only in January 1990. prises. Devolution of authority and the decentrali- 50 Eastern European Experience with Privatization zation of decision-making in the economy resulted These regulations provided a legal framework for in a far-reaching separation of the ownership of operating private businesses and opened the com- state assets from their day-to-day control. mercial sector to private initiative. Private activity 4.30. Reforms in the state sector extended not was constrained, however, by the need to obtain only to enterprises but also to individual units, such official approval prior to operating a business and as stores or service outlets. Changes at the level of also by strict size limitations. Additional legislation individual units resulted in the following three in the early 1980s increased the array of accepted arrangements. Independentaccountingarrangements legal forms of business organization. By the mid- created performance-based compensation for indi- 1980s, private business activity in the trade sector vidual commercial units, which maintained their could take a myriad of forms: artisan, private retail own accounts and were allowed to retain some trader, private caterer, small cooperative, and a portion of the unit's residual profits. Contractual form roughly analogous to general partnerships.' arrangements called for greater unit independence. The steady increase in the number ofprivate traders Managers gained the right to make product line, did not, however, translate into a corresponding supply, and pricing decisions. In return, they paid growth in the volume of sales; although private a set fee to the parent enterprise, and had an retail and catering establishments comprised close agreement to purchase certain goods from the to 40 percent ofthe total units in the sector in 1988, parent. Rental agreements removed the contractual they controlled only slightly more than 10 percent supply conditions on managers. Essentially, they of the market. were indistinguishable from familiar subleases.' Contract and rental unit workers retained the sta- Transformation from 1988 to 1990 tus of state employees, but by the mid-1980s, managers had acquired the right to hire and fire 4.33. In the period 1988-90, a reform strategy workers. Rental and contractual agreements were, was adopted that created incentives for state enter- however, limited to units of relatively small size. prise insiders to change and restructure their insti- 4.31. Contractual and rental shops, while numer- tutions on their own. Three legal regulations, the ous, were usually small, relatively under-perform- Company Law, the Foreign Investment Law, and ing establishments. Thus, their share of total the Transformation Law, gave enterprises the free- employment in the sector was nearly twice as large dom to sub-divide into smaller entities organized as as their share ofturnover, and per unit employment commercial companies, such as limited liability was less than half of the overall 1988 average in state and joint stock companies. enterprise units. Still, these arrangements were 4.34. The Company Law which came into force credited with improving the performance of the in January 1989 gave most enterprises the right to least profitable portion of the state trade sector and establish such subsidiaries as partnerships, limited injecting some market elements into retail and liability and joint stock companies, or economic catering enterprises. Contractual and rental ar- associations.6 The establishment of new companies rangements, however, had a somewhat perverse was encouraged by the granting of tax abatements; impact on the role of state enterprises in the provi- starting in 1988, all new businesses, including sion of consumer goods and services. Allocating those created on the basis of state assets, were given rental and contractual rights, in fact, became an three-year graduated reductions in their profit taxes.' animating factor in the economic activity of many Capital formation was also assisted by the Foreign state enterprises; it has been estimated that some Investment Law. In addition to allowing for 100 state enterprises received 40 to 50 percent of their percent repatriation of profits, the law permitted revenues from contractual and rental payments.' most Hungarian legal entities to enter, without government supervision, into joint ventures with The Creation of Private Businesses one or more foreign investors. Enterprise managers could thus deal with foreign investors, creating new 4.32. The liberation of private initiative, inde- companies mixing state-owned assets and foreign pendent of the developments affecting state enter- capital. The resulting joint ventures were also sup- prises and cooperatives in the trade and service ported by generous tax reductions. sector, began in the late 1970s with legislation 4.35. Unlike the Company Law, which allowed allowing for the creation of Civil Law partnerships only partial transformations, the Transformation and the enactment of the Law on Domestic Trade. Law sanctioned transformations of entire enter- Eastern European Erperience with Privatization 51 prises into joint stock or limited liability compa- sector throughout the period; their importance was nies. In the case of self-managed enterprises, the due not to the number of stores they controlled but change was initiated by a two-thirds vote of the to the prominence of their investments. Enterprise Council, and, until 1990, decisions to transform an enterprise, and the transformation Distribution of Property Rights plan itself, were not subject to ministerial supervi- 4.38. Partial or complete transformation of state sion.' Enterprises with more than 50 percent of enterprises was often accompanied by a significant their assets invested in other companies were re- transfer of property entitlements. By May 1990, quired to transform themselves within two years. ownership and organizational transfers had both Complete transformation was less appealing than diminished the size of the state sector and created a partial transformation since it required the new unique set of power configurations in the remain- company to assume the debt obligations of its state ing state-owned enterprises. Public attention fo- enterprise predecessor. Still, transformation held cused not on the satisfaction of consumer demand, potential benefits for enterprise employees, since but on the need to halt the uncontrolled "sponta- the Transformation Law permitted the distribu- neous"privatizationofstateassets.Thus,Hungary's tion of special "worker shares" with a value of up to first post-communist government assumed power 20 percent of the capitalization of the newly created with a popular mandate to slow the pace of priva- joint stock companies, at discounts of up to 90 tization in the trade sector. percent. Overall, there were ultimately very few total transformations, and most of the new com- C. Preprivatization Program pany formations involved spin-offs under the Com- pany Law. 4.39. Preprivatization9 is the only Hungarian Results of the Transformation Process privatization program designed specifically for the retail trade, catering, and service sector of the 4.36. The consequences of the last reforms of the economy. A draft law had been prepared by the last old regime can be assessed along two separate but communist government. It was driven by a need to connected lines: (1) the changes in the organiza- generate income for the state budget and to end the tional composition of the sector; and (2) the alter- abuses associated with "spontaneous privatization." ations in the distribution of property rights among The program envisioned the sale of a discrete the sectoral participants. portion of the state trade and service units. Shops operating under contractual or rental arrangements Organizational Composition were the primary targets of the program. Relations between these units and their parent enterprises 4.37. While the number of state trade enterprises made real-estate operations into a core activity of remained relatively constant in the period 1988- some state enterprises in this sector. By selling the 90, confirming the fact that complete transforma- rented and contracted shops to independent entre- tions played only a marginal role in this period, the preneurs, the program would eliminate this struc- impact of partial transformations was pervasive, as tural inefficiency. The Preprivatization Law was more than one-third of state shops changed their not, however, enacted until 1990, and the scope of organizational form. The shift of shops and cater- the program was reduced dramatically as a conse- ing establishments occurred exclusively in self- quence of this delay. administered enterprises or those founded by local 4.40. The Preprivatization Law, which took ef- governments. As the state enterprise sector shrank, fect on September 25, 1990, and the related legis- dramatic increases were registered in both the num- lation,'0 outlined the role of the SPA and identified ber of commercial companies and the number of the types of assets to be included in the program. stores they operated. Limited liability companies Auctions were established as the sole mechanism almost doubled, with a corresponding increase in for SPA-initiated sales. At first, all proceeds from the number of shops. Growth in joint stock com- Preprivatization auctions were to be contributed to panies was only slightly less robust. Almost two- the central state budget. Later, however, 20 percent thirds of the 5,577 new commercial company units of the proceeds from the sale of units belonging to were added between 1989 and 1990. Foreign inves- regional institutions was given to regional govern- tors were of marginal numerical significance in the ments and 50 percent of the proceeds from the sale 52 Eastern European Experience with Privatization of local units was channeled to the local govern- isting contracts, and obligations of the business. ments. Inventories were not included in sales. 4.45. As was the case with the Czech small priva- Assets in the Prep rivatization Program tization program, restrictions on the operation of privatized shops were permissible for certain cat- 4.41. Sale of several types of units involved in egories of units. In contrast to the Czech program, retail trade, catering, and services was mandated by restrictions could be maintained for a long period the Preprivatization Law, including: all units oper- of time-up to five years. During this time, a ating under a contractual or leasing arrangement at business could change its line of activity only with any time since December 31, 1988; all retail trade the approval of local authorities. units employing fewer than 10 people and all 4.46. Only Hungarian citizens or private legal catering and service establishments and hotels em- entities have been eligible to purchase the assets in ploying fewer than 15 people; and units involved in the Preprivatization Program. Nonetheless, there is the sale of gas, heating oil, petrol, and diesel fuels, speculation that foreigners may have participated However, a number of exclusions removed large in auctions as silent partners. groups of units from the program. Categories of shops, such as pharmacies, were exempt, as were The Allocation Process shops operating as part of a chain. 4.42. No later than 30 days after the effective date 4.47. The SPA immediately assumed ownership of the Preprivatization Law, state enterprises were of all units included in the program, forbidding required to give the SPA a list of all their units asset alienation and depriving the enterprise of the fallingwithin the boundaries of the program. Many unit's inventories. If a unit was to be sold through enterprises delayed reporting, while others, it seems, an auction, the SPA commissioned a private con- never reported at all. Moreover, the criteria for sulting firm to examine the unit's assets and make inclusion were vague, and a majority of large trade a valuation of the unit's worth. On the basis of this enterprises with potentially eligible units could information, the SPA would determine the starting have argued that their shops were part of a chain of price for auction. stores and should thus be excluded from the pro- 4.48. Auctions are conducted by independent gram. It is alsonot clear whether the SPA had strong agents designated by the SPA. If no bids are offered enough incentives to insist on the inclusion of a at the initial asking price, a second auction at a large number of units in the program. Studies lower starting price determined by the SPA takes performed by the Central European University place. If the unit is not sold after the second auction, Privatization Project suggest that enterprises typi- it may be sold through other means determined by cally engaged in substantial negotiation with the the SPA. SPA, which often resulted in the inclusion of only 4.49. The Preprivatization legislation stipulates the least valuable, often loss-making, units. that if an auction yields equal bids for the same 4.43. As of August 1993, 421 enterprises had property certain groups and interests should be reported 10,674 units to the SPA. This represents given specific priority. First among these are the approximately one-third of the trade, catering, and insiders: shop managers, employees, business asso- service unitsoperated bystate enterprises in 1990." ciations formed by the shop employees, and em- Roughly 50 percent of the units in the program ployees or business associations of the enterprise to were retail shops, 30 percent restaurants, and 20 which the shop formerly belonged. These groups percent service establishments. have the privilege, in that order, of winning any 4.44. Typically, shops in the program were owned auction in which they match the highest bid. Simi- by enterprises founded by either local or regional lar preferences were also granted to purchasers governments. Generally, neither the shops nor offering to pay in cash. AfterJune 1992, individuals their parent enterprises owned the premises on who were parties to contractual or rental agree- which they operated, but rented them from local ments involving the units in the program could governments on very favorable terms. In over 70 avoid the auctions altogether and purchase their shops percent of the sales, the buyer did not acquire the at the starting price determined by the SPA. Auction title to the premises but only the right to rent for a winners conclude a transfer oftitle agreement with the period of 10 years. Units were sold as going con- SPAwithin 15 days of the auction. Buyers maypayin cerns, and included equipment, brand names, ex- cash or in Compensation Bonds awarded to Hungar- Eastern European Experience with Privatization 53 ian citizens whose property was expropriated during bargaining position between the local governments the old regime." Buyers may also obtain preferential (which owned the premises) and their prospective credit under the special "E-credit" program, de- tenants. Many new owners were forced to accept signed specifically to finance purchases of state the local government's rent demands or risk denial assets.'3 of access to their newly purchased businesses. Re- fusal to accept the terms offered by the local govern- Results ment, followed by a withdrawal of the intent to purchase, forced the auction winner to forfeit the 4.50. By the end ofAugust 1993, Preprivatization auction deposit. proceedings had been completed with respect to 4.54. The demand for Preprivatization units was 8,723 of the 10,674 reported units, but this figure also dampened by the lack of financing. Although does not represent the number of units actually the E-credit program was specifically targeted to privatized, since in 1,707 cases ownership rights aid small domestic investors in the purchase ofstate were transferred to state-owned organizations." If assets, the commercial banks that distributed the these intra-state transfers are subtracted, 7,016 loans supported by E-credits were cautious, de- units have left the state sector through the program. manding collateral far in excess of the amount most Preprivatization has thus been responsible for the applicants could provide. privatization of more than 23 percent of the state 4.55. Preprivatization auctions appear to have trade and catering units existing in 1990. served to distribute the smaller state trade units to 4.51. Of the units privatized by the end of August outside investors while keeping the larger units for 1993, 4,731 were sold at auction by the SPA. This the most part in the hands of insiders. figure, however, overstates the importance ofacution procedures in the program, since the SPA also D. First Privatization Program classifies as auctions cases in which the current contract or rental holders exercise their option to Objectives purchase their units. We estimate that fewer than 4,000 shops were in fact sold through competitive 4.56. In September 1990, the SPA launched the procedures through August 1993. The remaining First Privatization Program (FPP), its first attempt shops were restored to private individuals or to to privatize entire state-owned enterprises. The non-stateorganizationssuchascooperatives,judged FPP was to be both a testing ground for future to be the true owners, or were sold by the enterprises programs and, like the Preprivatization Program, a to which they belonged, to repay enterprise debts. source of revenue for the state budget. With the 4.52. Although these non-auction transfers de- FPP, it was the SPA's intent to assert its control over creased the revenues the state obtained from the the Hungarian privatization process, heretofore program, they had offsetting benefits. They expe- dominated by enterprise managers. dited the resolution of pre-existing property dis- 4.57. Initially the SPA selected 20 enterprises putes which the Hungarian legal system could not deemed attractive for the FPP, 6 of which were in otherwise process quickly and which resulted in a the trade sector." The program had three main transfer of complete ownership rights to enterprise objectives: (1) the maximization of sale proceeds; outsiders. It should be noted, however, that the (2) the design of the post-privatization ownership units transferred through non-auction proceedings and business structure of the company; and (3) the were among the smallest shops in the bolstering of Hungary's capital markets. Preprivatization Program. 4.58. Regarding sale proceeds, it is clear that the 4.53. For the units sold by auction, the demand SPA had high financial expectations of the FPP, was limited by several non-price factors. Para- and the valuation of the companies in the program mount among these was the uncertainty surround- assumed a very high price/earnings16 ratio (P/E) of ing the transfer of the property rights. No legal 8 to 12, or one-and-a-half to two times the book provisions seem to have governed the process by value of the assets (estimated at Ft 73 billion: the which leases were negotiated after auction, except 1990 equivalent of US$1,123 million). The priva- for the length of term, which was set at 10 years. tization proceeds were intended to help pay off the This fact, coupled with the 15-day deadline for the state debt, and thus proceeds were not to be used to auction winner to secure the l!ase from the real restructure the companies themselves: in only one estate owner, created a significant imbalance in the of the six enterprises did the terms of reference 54 Eastern European Experience with Privatization mandate an increase in the share capital as a com- source of many problems. The privatization plans ponent of privatization. for trade enterprises generally call for a sale through 4.59. The second objective, that of shaping the a tender procedure of a significant stake in the post-privatization structure of the company, was company to one or several strategic investors, to be reflected in the degree of detail with which the followed later by a sale of shares to the public. terms of reference specified the post-privatization However, as of March 1993 the SPA was unable to ownership distribution, including the number of finalize sale contracts with core investors for any of shares to be sold to foreign and domestic institu- the enterprises involved. The lack of strategic sales tional investors, small investors, employees, foreign has delayed the public offerings of shares and forced and Hungarian technical partners, etc. In the trade the SPA to rethink its original strategy. The SPA and service sector, for example, it was proposed to has had considerably greater success in selling off preserve the three chains of hotels and supermar- individual assets of the firms, plowing the revenue kets included in the program in the hands of obained from these sales back into the companies in Hungarian institutional or technical investors, and an effort to increase their attractiveness. to auction only minority stakes to other investors. 4.63. Despite some difficulties, the FPP played an The SPA`s concerns extended not only to planning important role in the subsequent Hungarian priva- the initial ownership structure, but also to seeking tization efforts. On the one hand, the SPA has ways to ensure the continued maintenance of the moved to a more decentralized approach. On the basic ownership pattern of domestic control. Simi- other hand, certain key ingredients in the design of larly, the SPA was concerned with a number of the FPP (such as the focus on privatizing ongoing operative details ofpost-privatization restructuring enterprises, the restructuring of enterprises prior to and required elaborate new business plans for each sale, and the use of non-SPA personnel) can be company. discerned in subsequent attempts to privatize many 4.60. Finally, the SPA also wanted to use the FPP enterprises in the trade sector. to aid the development of Hungary's capital mar- kets and it consequently placed much emphasis on E. Self-Privatization the public trading (on the Budapest stock market) of the securities of the privatized companies. Objectives 4.61. The three objectives of the SPA were not necessarily complementary. Profit maximization, 4.64. In mid-1991, the SPA embarked on a priva- best pursued through attracting foreign invest- tization program that promised better results than ment, was in conflict with the objective of design- the Preprivatization and First Privatization Pro- ing the long-term ownership structure and business grams. The new program involved a wide range of plans of the privatized entities, as well as with the parties and outside expertise, and also provided a wish to retain certain sensitive assets of the Hungar- measure of bureaucratic immunity for possible ian economy in Hungarian hands. Similarly, the failures. This new program, Self-Privatization, was development of a smoothly functioning, liquid not created especially for trade enterprises, but stock market did not accord with the desire to trade and service enterprises have played a pro- create a semi-permanent ownership structure. nounced role. Elaborate sectoral plans and extensive enterprise 4.65. Self-Privatization's core feature is a shift of restructuring schemes raised the cost of the pro- responsibility for transforming and privatizing (pri- ceedings, thus also decreasing the total proceeds. marily small) enterprises from the SPA to private intermediaries. Within the framework of a general Results contract defining the responsibilities of each parry, the SPA transfers the right to privatize selected state 4.62. Efforts to sell entire enterprises have gener- enterprises to a group of independent consulting ally failed. This has been due to a large extent to the firms. To assure the proper alignment of incentives, competing objectives of the FPP. Some of the the SPA ties the remuneration of the participating failures were also linked to the poor performance of consulting firms to proceeds generated through the trade enterprises since 1990, when the value of privatization. Additional bonus payments are linked most of the companies plummeted. Decisions re- to the speed with which the sales are completed garding the proportion of shares to be sold to core and, for sales above the offering price, are deter- investors and the timing of such sales have been the mined by independent accountants.17 Eastern European Evperience with Privatization 55 4.66. Self-Privatization was also designed to se- second phase. Forty-three consulting firms signed cure the cooperation ofenterprise managers. Enter- the second phase frame contract, which was also prises participating in Self-Privatization would due to expire in December 1993. themselves enter into contracts with the consulting firms of their choice, although they would be Assets in Self-Privatization limited to firms pre-approved by the SPA. The consulting firms would then conduct the valuation 4.71. In September 1991 the SPA announced of the enterprise and create a transformation and that state enterprises with fewer than 300 employ- privatizationplan. Insiderswerefiurtherencouragedto ees, owning equity of less than Ft 300 million, and participate by a system of important preferences. maintaining a sales turnover of less than Ft 300 4.67. In the first phase of the program, employ- million, could participate in the Self-Privatization ment and turnover ceilings generally restricted program. The number of companies included in Self-Privatization to small enterprises. Although the program grew to 433 within six months. trade enterprises comprised only a small portion of 4.72. Service enterprises, broadly defined, make the program, service enterprises were prominent. up 62 percent of all participants in Phase I, with Roughly one year after Self-Privatization began, consumer service enterprises comprising 43 per- the program was extended to somewhat larger cent. In contrast, trade enterprises constitute only firms, and the proportion of trade and service 2 percent of the total, but when measured by enterprises diminished. employment and turnover, they are significantly 4.68. Over 80 enterprises joined the program, larger than service enterprises. The second phase of motivated by, among other factors, a perception Self-Privatization involved somewhat larger firms. that Self-Privatization might provide the best chance The SPA's list of 279 eligible enterprises, published for an infusion of new capital from outside inves- in the fall of 1992, included firms with under 1,000 tors. Trade and service enterprises, in addition, employees, assets of less than Ft 1 billion, and hoped through joining the program to cecover annual turnover of under Ft 1 billion. As of June some of the units they had lost to Preprivatization. 1993, 13 of these enterprises had declined to par- But the vast majority of the enterprises involved ticipate. There have been no additional entries . It entered the program as a consequence of being is worth noting that although the program's eligi- included in the lists of participants drawn up by the biliry rules were changed to admit larger enter- SPA. Although the firms are nominally free to exit prises, the trade enterprises included in Phase II are from the program, such behavior is discouraged by significantly smaller than those in Phase I. the prospect of "forced transformation." This pros- pect was given added currency by the legislation The Allocation Process passed in July 1992 that set June 30, 1993, as the deadline for the initiation of transformation in all Sef-Privatization involves a two-step pro- state enterprises. Enterprises not meeting the dead- cess. First, with the assistance of the consulting line on their own are subject to SPA-directed privati- firms, the enterprises are to be transformed into zation. commercial companies (corporatized). Then, they 4.69. In the summer of 1991 the SPA invited all are to be privatized through the sale of company consulting firms registered in Hungary with either shares. stock capital or bank guarantees of at least Ft 10 4.74. Thetransformationcontractsignedbetween million to apply to participate in Self-Privatization. a participating enterprise and a consulting firm Out of an applicant pool of 150, 83 firms were commits the firm to help the enterprise decide how chosen. Upon acceptance, the firmssigneda"frame best to transform. As part of this effort, the firm contract" with the SPA, which gave them exclusive conducts a valuation of the company, determines rights to sell the shares of companies transformed which assets, if any, should be sold prior to corpo- throughSelf-Privatization.Thecontractswereorigi- ratization, appeals for the return of units taken nally scheduled to expire in March 1993, but they from the enterprise in Preprivatization, and sets the were extended by a second frame contract to the offering price for the company shares. A consulting end of December 1993. firm may also determine that the enterprise is 4.70. Results of the first phase of Self-Privatiza- unable to satisfy its debt obligations and recom- tion were considered so promising that in August mend putting it into bankruptcy. If the consulting 1992 the SPA announced the st-rt of the program's firm determines that the company is solvent, it will 56 Eastern European Experience with Privatization suggest a business plan for the new company. All cates the incidence of transformation of trade and these tasks entail extensive and time-consuming consumer service enterprises in Self-Privatization. negotiations among enterprise insiders, consulting Overall, 126 out of the 220 trade and service firms, and the SPA. The consulting firms must enterprises (57 percent) have been transformed balance the interests while simultaneously weigh- successfully in the two years during which the ing the need to raise additional capital for the program has operated. company and to resolve the issues of future owner- 4.77. While transformation is simply a change of ship quickly. Disputes between consulting firms corporate form, privatization is the real objective of and enterprises over business plans have at times led the program. But, as can be seen from Table 4.2, to the cancellation of the firm-enterprise contract. the number of trade and consumer service enter- 4.75. In addition to the responsibilities related to prise sold in Self-Privatization so far is modest: a enterprise transformation, the basic frame con- total of 73, or 33 percent, out of the 220 trade and tracts give the consulting firms exclusive rights, service enterprises included in the program have until their contracts expire, to sell the shares of new been fully sold. Slightly over 60 percent of the companies. All sales of controlling stakes must be enterprises that have been transformed have later conducted by tender, the procedures for which are been privatized. With the exception of ESOP pur- defined in SPA regulations and in legislation. All chases, all sales which have taken place have been Self-Privatization sales include preferences for en- through competitive tender procedures. terprise insiders; the general framework of these is 4.78. As regards the buyers ofthe trade and ser-!ice spelled out in the privatization legislation in effect enterprises, there are no foreign investors, and the at the time of the signing of the frame contracts. ESOPs have played only a minor role. Self-Privati- zation sales have been dominated by domestic and Results enterprise insider investors. 4.79. Almost half of the 147 not yet privatized 4.76. The results of the Self-Privatization Pro- trade and service enterprises in Self-Privatization gram for enterprises in the trade and service sectors are currently under (or have concluded) some form can be evaluated on the basis of the number of of bankruptcy or liquidation proceedings. The enterprises transformed and, more important, the large number of enterprise terminations" in the number of enterprises privatized. Table 4.2 indi- trade and service sector may indicate that many Table 4.2: Hungary: Privatization of Trade and Service Enterprises in Self-Privatization, as of June 1993 Trade Enterprises Consumer Services Enterprises Phase I Phase II Phase I Phase II Total No. of Enterprises 8 21 179 12 No. of Transformed Enterprises 6 14 98 8 No. Completely Sold 4 2 67 0 No. Partially Sold 0 1 9 1 Mean Value of Sale (Ft 1,000) 81,518 332,407 20,716 - Percent of Starting Price 63.7 88.8 84,4 No. of Majority Stakes 4 2 54 Mean Size of Majority Stake(%) 83.7 75.5 85.9 Source: PrMan Sel-Privatization data base, July 1993. Eastern European Experience with Privatization 57 enterprises lost their economic viability with the 4.82. The range ofdifficulties encountered by the removal of their key shops and outlets in the course SPA is illustrated by the ongoing privatization of of Preprivatization. But termination proceedings the KOZERT food chain. In October 1992, ap- may also have resulted from the decisions of both proximately one-half of the chain's 330 stores were enterprise insiders and consulting firms. The start sold at auction. After much debate, the SPA an- of termination proceedings usually signaled the nounced, in April 1993, its decision to create alow- end of the consulting firm's work, and thus a priced "discount" network of food stores, and it is conclusion to a process that has often proved to be now seeking to attract non-profit companies to of limited profitability for the firms. Termination purchase the remaining stores, with the agreement proceedings also gave the enterprise insiders the that they will sell low cost food items purchased opportunity to purchase valuable assets unencum- directly from producers. Neither the exact number bered by debt and contractual obligations. Such of stores to be included nor their identity has been proceedings were involved in the privatization of announced, and until the issue is resolved no sales approximately the same number of Self-Privatiza- can be concluded. The fate of the units not in- tionenterprisesastransformation-tendersales.The cluded in the discount chain is similarly unclear: large number of enterprises in the program that they may be offered individually, or as part of an remain untransformed and unsold suggests that alternative chain, or as part of a franchise system. Self-Privatization may in time become a program Similar problems in balancing a variety of interests of privatization of individual assets through bank- and objectives in privatization have appeared in ruptcy, rather than a sale ofgoing concerns through different guises in many of the SPA's efforts to competitive tenders. engineer new trade sub-sectors. In the household appliance sector, for example, the privatization of a F. SPA Plans for the Remaining State Units large enterprise is being held up by the SPA's desire to privatize two "competitive partners" simulta- 4.80. Over 10,000 shops and catering establish- neously. Committed to an ambitious technocratic ments will remain state-owned even after the end of model for privatizing the remainder of the state the Preprivatization and Self-Privatization Pro- units, Hungary is likely to continue to feature a grams. The SPA is currently in the process of sizable number ofstate-owned trade establishments devising strategies for the privatization of these for the next several years. units. However, it is impossible to predict when and how the units will be privatized. These units are G. The Transformation of Hungarian Consumer a varied assortment. Some are specialty stores that Cooperatives form a part of a state monopoly (these include over 1,000 pharmacies). The largest portion of the re- 4.83. The recent history of Hungarian consumer maining units serve as retail outlets for enterprises cooperatives parallels, to some extent, that of Hun- involved in some form of manufacturing. With garian state trade enterprises. Changes in the struc- respect to pharmacies, the SPA plans to privatize ture of the cooperatives have been occurring for each store separately through sales to qualified several decades and, in the last years of the old individuals. But with respect to the other remain- regime, a great number of stores passed out of ing state stores, the SPA plans usually envision the cooperative ownership. Since 1990, significant sale of many units grouped together in chains and structural transformations have taken place and integrated with wholesale and distribution facili- there has been a large increase in rental agreements, ties, which would allow for economies of scale in through which the cooperatives have significantly purchasing and distribution. decreased the number of stores under their direct 4.81. In designing the new companies that will control. The passage of a comprehensive coopera- regroup the existing units, the SPA is working with tive transformation law in 1992 has resulted in a officials from various ministries to produce an more democratic structure of cooperative gover- analysis of the particular sub-sectors of retail trade, nance. Overall, the number of retail and catering to determine the optimal number of firms that shops owned by consumer cooperatives has de- should be formed in light of the size of the respective creased between 1988 and 1992 by approximately markets and the concentration patterns found in 30 percent, from 23,187 to 16,185. similar sub-sectors in Western economies. The SPA's 4.84. Consumer cooperatives underwent signifi- efforts to date have achieved only modest success. cant reforms in the last three decades of the old 58 Eastern European Experience with Privatization regime. Beginning with the 1960s, cooperatives supervisory board, and new elections for other were substantially consolidated. At the same time, representative organs. Each cooperative had a choice the administrative controls over the activities of between re-registering under the new law or trans- cooperatives were relaxed. Finally, the manage- forming itself into a limited liability or joint stock ment ofcooperative stores was transformed through company. Groups of cooperative members could the introduction of rental agreements into the also elect to secede from the larger cooperative. cooperative sector. By 1988, 6,119 cooperative Only two consumer cooperatives elected to trans- rental arrangements were in existence, covering 26 form themselves into joint stock companies, and 10 percent of cooperative-owned establishments. new cooperatives were formed as a result of seces- 4.85. At the end of 1988, consumer cooperatives sion from their parent cooperatives.' The new controlled over 25 percent of all the units in the elections resulted in the removal of 14 percent ofall trade and catering sector and accounted for ap- cooperative presidents, 29 percent of managers, proximately 30 percent of sectoral turnover. Al- and 36 percent of supervisory board members. though formal government controls over 4.89. The changes in the management and com- cooperatives had become relatively weak, the gov- position of the cooperative sector, however, had ernance of consumer cooperatives was still not begun earlier. In 1990, SZOVOSZ (the Commu- significantly influenced by the democratic organs nist Party-sponsored National Federation of Co- originally designed to give the members a voice in operatives) was dismantled, to be replaced by decision-making. voluntary national associations for each type of coop- 4.86. The number of retail and catering units erative. The new National Federation of General owned by consumer cooperatives dropped sharply Consumer Cooperatives (AFEOSZ) focused its arten- between 1988 and 1990: the aggregate loss of 5,552 tion on coordinating the economic activities of coop- shops represented a decrease of 24 percent. This eratives and managing its own considerable assets.21 dramatic change was a result of sales and other 4.90. Between 1990 and 1992, cooperatives ex- transfers of assets by the cooperative management perienced an 8 percent net decline in the number of in the period leading up to the first free elections. units. The actual movement of assets was much The overall impact of ownership transfers on the greater, as cooperatives sold some units and ac- economic position of the cooperative sector during quired others, and also restructured the operations 1988-90 was mixed. In line with the transfer of a of many remaining units. These changes have been large number of small shops, employment per unit generally related to an increased concern with prof- more than tripled, leaving the cooperative stores itability and risk diversification. Specialty shops with the highest level of employment per unit of have generally been sold off or their line of business any ownership group. At the same time, turnover has been changed, and the number of stores offer- per unit in cooperative-owned establishments in- ing multiple types of goods or services has ex- creased by over 40 percent, but this still left it at panded. Some cooperatives fared better than others only 50 percent of the average for the state sector. in the recent restructuring. A number were left 4.87. Since 1990, the total number of units owned practically "empty" as a result of having sold most by consumer cooperatives has remained remark- of their assets. It is not possible to determine how ablystable. This aggregate stability, however, masks many of these sell-offs were triggered by financial a significant degree of restructuring. Important distress, but it is clear that a portion of the coopera- changes have occurred in the business management tive sector is in crisis. As of the end of 1992, seven and composition of the cooperative stores, as well consumer cooperatives had been liquidated be- as in the overall governance of the cooperatives. cause of bankruptcy. 4.88. The institutional restructuring of the coop- 4.91. The proportion of cooperative units rented erative movement after 1990 has been quite im- out to private individuals grew rapidly after 1990. pressive, although most of the changes are too In the two years following the change of regime, the recent to have had a measurable impact on business number of leased units went up from 4,612, or operations. Legislation in 1992 required the trans- approximately 27 percent, to 7,242, or 45 percent. formation of all cooperatives in Hungary by June The leases have generally been for terms no longer 31, 1992. This legislation attempted to strengthen than five years and have contained restrictions on the ability of members to influence the governance changes in the line of business (but not in the of the cooperatives: the legislation mandated new selection of suppliers). A significant proportion of democratic institutions, such as a more powerful these leases are believed to have buyout clauses and Eastern European Experience with Privatization 59 many rented units are expected to leave the coop- commercial establishments, offering a wide variety erative sector in the near future.22 of products and services. They also function in- 4.92. Overall, consumer cooperatives are currently creasingly as real estate owners, preferring to parcel in the process of diversifying their traditional focus out the actual management of their stores to private on providing food and basic necessities to rural parties. The designation of a store as a "coopera- inhabitants. While still concentrated in non-urban tive" now serves more to identify ownership than to settings, consumer cooperatives now own a mix of indicate management structure or social function. Notes clarified by the Circular Letter; the Guidelines for the Sale ofAssets regulated the valuation of assets in the program; 1. Law No. VI of 1988 (as amended) "On Business Societies, detailed instructions on auction procedures were provided Associations, Companies and Ventures" ("Company in the Auction Regulations. Law"). 11. SPA, Department of Privatization. 2. Joint stock companies usually operate as chains of more 12. Although Hungary has no in-kind reprivatization or res- than ten units, and most of them were carved out of state titution program, the government has awarded approxi- companies between 1988 and 1990. Limited liability mately Ft 87 billion in Compensation Bonds. These companies, in contrast, are simple structures, usually interest-bearing bonds may be used to purchase any state consisting of one to three units. They are likely to have property privatized by the SPA, land from local coopera- been created as a means of gaining complete ownership tives, and houses from local governments. The bonds may rights over individual scores, as well as by private persons also be exchanged for shares in the Social Security Fund. starting new commercial establishments. Unlike limited They are freely tradable on the Budapest Stock Market. liability companies, some joint stock companies are still 13. E-credit is available to Hungarian natural persons and believed to be essentially state owned. Since most of these companies owned by them, for all state property pur- joint stock companies are either partially or totally owned chases. Loans are refinanced by the Hungarian Central by state entities, and since, in 1990, joint stock companies Bank and distributed by commercial banks, which typi- operated slightly more than 3,000 shops and restaurants, cally require 150 percent collateral from any borrower. a large proportion of this figure should be added to the The interest rate for these loans is set at 60 percent of the 17,410 establishments listed in Table 4.1 as state owned Central Bank's refinancing rate. in 1990. 14. Normally, only private parties can acquire units in the 3. Rental agreements between enterprises and private man- program. But transfer of units to state bodies occurred in agers were subleases since the enterprise usually did not some cases in which the unit functioned as a component own the premises on which its stores were located. Instead, of a larger organization. For example, where a food can- the enterprise leased them from the local municipality. teen operated within a state hospital, the right to rent our 4. See Eva Palocz, "The Emergence and Implementation of the canteen was transferred to the hospital. It is assumed the Small-Scale Privatization Program in Eastern Euro- that many of these units have since been sold or rented to pean Countries: The Case of Hungary," Mimeographed, private parties. Kopint Datorg, June 1992. 15. It was not possible to identify accurately the retail trade 5. "Civil Code partnerships" focused on the provision of portion of some of the manufacturing state enterprises in non-material services; members bore joint and several the FPP. The decision was thus made to include here only liability for partnership obligations, those companies which were primarily active in retail 6. Economic associations under the Company Law are enti- trade, catering, and services (including the hotel industry). ties composed of legal persons, created to coordinate 16. Earnings are after-tax, assuming an effective corporate tax commercial activity; they are not independent profit- rate of 50 percent (which is very conservative). producing entities. 17. For the Self-Privatization Program, the SPA established 7. Profit taxes were reduced by 55 percent in the first year of thesubsidiarycompany"PriMan" (shortforPrivatization operations, 35 percent in the second year, and 25 percent in the Management). PriMan's responsibilities include the dis- thirdyear. These tax preferences were withdrawn in 1992. semination of information to enterprises and consulting 8. Registration was a judicial process, with the courts receiv- firms, the preparation of recommendations on transfor- ing the plan of transformation, the profit and loss state- mation proposals, and the evaluation of the performance ment, theminutesofthemeetingsconcerningtheapproval of consulting firms. PriMan also documents the progress of the plan, and the auditor's report on the profit and loss of Self-Privatization transformations and sales. statement. 18. The number of participating enterprises dropped to 421 9. The "Preprivatization" Program owes its name to the as of the end ofJanuary 1993. belief that the sale oFsmall stores was just the beginning of 19. "Terminations" include cases ofenterprises put into bank- the privatization process, the most significant part of ruptcyorunderjudiciallY supervisedliquidation,aswellas which was to be the privatization of large enterprises. those ofenterprises liquidated by a decision of the founder 10. This legislation consisted of Laws No. VII and LXXIV, orbyanagreementbetweenthecreditorsandtheenterprise. and several supporting documents: the Circular Letter; 20. Report on the Operation ofConsumer Cooperatives in 1992, the Guidelines for the Sale of Assets; and the Auction National Federation of General Consumer Cooperatives, Regulations. The types of assets to be included were page 2. 60 Eastern European Experience with Privatization 21. Manyofthecooperativewholesaleenterprisesanddepart- 22. Statistical Data for Consumer Cooperatives for 1990, ment store units built in the 1970s were owned directly by AFEOSZ, page 35; Report ofthe Consumer Cooperatives to the national organization and passed on to AFEOSZ. the 2nd Congress, 1992. *OChapter Five Survey of Privatized Enterprises' A. Introduction The evidence collected in the survey clearly indi- cates that new entrepreneurs, not connected with the 5.1. The survey presented here has been in part predecessor retail establishments, bring in the much- designed to enable policymakers to draw some needed capital engage in signficantly more restructur- conclusions from the experiences of the Czech ing, and generally serve as agents ofchange in the sector. Republic, Poland, and Hungary in privatizing the 5.5. Much of the change in the consumer sector retail, catering, and service sectors of their econo- in Eastern Europe did not come from traditional mies. In particular, it was thought that some lessons privatizations, but from an explosive growth in the from these experiences might be drawn with re- size of the new private sector (which, however, spect to the prospects of small privatization in the often uses real estate previously controlled by the countries of the former Soviet Union (FSU). state). The growth of new businesses is even more 5.2. Some of the survey results are, ofcourse, not likely to be necessary in the FSU countries, where geared to any policy recommendations. They at- the density of retail and service outlets in relation to tempt instead to capture the specific texture of local population is only 20 to 30 percent of what it is in conditions, which may in fact be difficult to repli- the three Central European countries and the more cate in any other place. Many factors only margin- advanced Western economies. If privatization is ally captured by the survey, such as macroeconomic conceived as a process of releasing real estate from the conditions in the three countries and the reform of state to private parties, much ofthe process, by includ- the wholesale sector, may also limit the applicabil- ing the creation of new businesses, will automatically ity of their experience to other areas. Nevertheless, lead to an increased participation ofoutsiders. some conclusions from the study, reinforced by the 5.6. The survey clearly supports the conclusion survey results, have potentially important implica- that the security of property rights in the newly tions that merit testing in the other countries of the acquired businesses is very important for the extent region. of post-privatization restructuring and investment 5.3. The most important of these conclusions is in the sector. In particular, transfers ofpremises on a proposed redefinition of the concept of small-scale which the new businesses are located should involve privatization, and the resulting recommendation either sales or leases of long duration. for policymakers to refocus their approach to privatizing the retail and service sectors by shifting B. Population and Sample Selection the emphasis fom the privatization ofsmallbusinesses in the consumer sector to a transfer ofjuse rights in real 5.7. The sample population was taken from estate. categories of economic units that were both repre- 5.4. Another important result of the survey con- sentative of the retail trade, catering, and service cerns the role of outsiders in small privatization. sector and consistent across countries. 62 Eastern European Experience with Privatization Population Selection some degree ofsample bias was introduced through Initial Conditions the exclusion of other types of units. Thus, for example, the exclusion of bookstores and pharma- 5.8. The study rationale dictated many of the cies, both of which were frequently prevented from initial conditions applied to the population selec- changing their line of business, may well have n ue decreased the percentage of units found to operate tion. The followmng conditions were used for an. . with such restrictions. initial screening of establishments.wihscretcio. 5.12. Further, in order to ensure cross-country * The units had to derive the major part of their comparability of the sample, a quota was adopted income from non-manufacturing commer- for each category of units in the sample. In each cial activity in retail trade, catering, or services. country, the sample population was thus composed " The units had to operate a business (rather of the following ratio of businesses: 40 food stores; than solely owning real estate). 20 household necessity or clothing and textile stores; 15 restaurants; and 25 service establish- * The current owners had to have acquired ments. These proportions are roughly equivalent to their businesses through some form of legal those found in the data base for the Czech small privatization. privatization program, which was the most exten- * The owners of the businesses had to be the sive compilation available. There was no reason to initial private purchasers. assume significant Hungarian or Polish divergence from these ratios. * The businesses had to have been in operation for at least one year. Locational Distribution * The businesses had to employ 50 or fewer individuals. 5.13. Attempts were made to ensure locational distribution along two separate dimensions: geo- 5.9. Unavoidably, the initial set of conditions graphic distribution and population density. In resulted in the exclusion ofsome groups of privatized order to adjust for regional differences in privaciza- units. Also, differences among the three countries tion patterns, the sample population was drawn from in both the pre-reform sectoral composition and aselectedsetofrepresentativeareaschosenonthebasis the subsequent methods of privatization affected of their proximity to national borders. In both the the relative importance of the uniform conditions Czech Republic and Hungary, five regions were se- for selection of units for the survey. In light of the lected. Because of the greater degree of decentraliza- delayed timingofcooperative transformation in Hun- tion of the privatization process and the relatively gary and the Czech Republic, the requirement of at larger size and population, 25 different sampling least one year ofoperation led to the exclusion of units areas were selected in Poland. In each geographic privatized by Hungarian and Czech cooperatives. region, the sample population was drawn from a mixture of urban, suburban, and rural localities. Conditions Concerning the Line ofBusiness Sample Selection 5.10. Concern over the potential impact of fac- tors unique to particular types of businesses in one 5.14. The sample consisted of 300 privatized es- or more of the countries led to the adoption of a tablishments (units) in the retail trade, catering, second set ofselection criteria, designed to decrease and consumer service sector in the Czech Republic, the variety of the sampled businesses while main- Poland, and Hungary. One hundred interviews taining the representative character of the sample were conducted in each country, but some respon- population. The following categories of units were dents failed to provide adequate answers to some selected, on the basis of their representation in the questions. economies of the Czech Republic, Poland, and 5.15. The Czech sample was drawn exclusively Hungary: food stores; household necessity stores; from units privatized through the country's small clothing and textile stores; restaurants; and service privatization program. The Hungarian sample was units.- selected from two separate sources. One-half of the 5.11. A large proportion of privatized businesses sample was fashioned from randomized regional fall under one of these classifications. However, lists of businesses privatized through the country's Eastern European Experience with Privatization 63 Preprivatization Program. The remaining half of managers (21) who were interviewed. A significant the survey was chosen through a randomized list of characteristic of present owners was their previous phone numbers of units listed in the 1989 Hungar- status. In Hungary, 76 percent had previously been ian phone directories. The sample in Poland was outsiders, while in the Czech Republic and Poland constructed entirely from randomized 1989 lists of only 49 percent and 38 percent, respectively, had state sector units existing in 25 geographically been outsiders. Theprevious status ofthe interviewee distributed census regions. The distribution of owners was very important in distinguishing clearly surveyed units by sector, type of location, and size between insider-and outsider-dominatedfirms. This (in square meters) is shown in Table 5.1. is discussed further, below. C. Participants and Assets Nature of the Conveyed Assets Status of Interviewees/Owners 5.17. Most of the privatized units were trans- 5.16. Wherever possible, the interviews were con- ferred to the new owners without equipment (Table ducted with the owners of the businesses. Only in 5.2). While the survey did not ask whether the Hungary was there a significant number of general privatized units had taken over a previously going Table 5.1: Sector, Location, and Size of Surveyed Units Percentage of Valid Responses Type of Unit Czech Republic Poland Hungary By Sector: Shop 60 61 58 Restaurant 15 15 16 Service Outlet 25 24 26 By Location: Central, Commercial Area 39 41 64 Suburban Area 59 40 34 Rural Area 2 19 2 By Average No. of m2 Used for Display or Service: Shop 62 75 71 Source: Survey. Table 5.2: Parts of the Business Included in the Transfer Number of Units for Which a Given Part of the Business Was Transferred' Part of the Business Czech Republic Poland Hungary Premises 100 90 83 Equipment 35 36 31 Land 20 14 9 Building 28 28 29 No. of Observations' 100 90 83 Number of units for which an indicated part of the business (premises, equipment, etc.) was transferred (rented or purchased). For example, equipment was transferred in 35 out of 100 transferred units in the Czech Republic. 2 Number of valid responses, defined as responses indicating that at least one part of the business was transferred. 64 Eastern European Experience with Privatization concern or just the assets of the old establishments, D. The Transfer Process most units did not assume any debts at the time of Lease versus Purchase transfer (Table 5.3).3 5.18. The data indicate that smallprivatization is 5.20. As was noted above, the great majority of primarily nota transfer ofbusinesses, but ofassets, and the premises on which the privatized establish- more particularly, ofpremises or real estate. Indeed, ments are operating have been leased rather than the decoupling of premises from the business of the sold. For the three countries taken together, some state enterprises and state-dominated cooperatives three-quarters of the survey units were leased. intent on defending their empires - the phenom- Moreover, there were no very significant differ- enon is particularly stark in Poland - may be one ences among the three countries in this respect. of the main factors responsible for the success of small privatization in the three countries. Features of the Rental Contract 5.19. The premises themselves are most often not privatized in the strict sense of the word. Since 75 5.21. Significant differences were found in the percent of the privatized units lease, rather than durations of leases among the three countries, with own, the premises on which their businesses are a median duration of 10 years in Hungary, 5 years operated, the legal title to the most important asset in the Czech Republic, and only 3 years in Poland. controlled by the majority of the "privatized" busi- Indeed, Poland has a very high proportion (44 nesses in the retail and service sector is never percent) of leases with terms of two years or under conveyed into private hands. It is worth noting that (Table 5.5). Since short duration greatly reduces only 12 percent of the leased premises are owned by security of tenure, it is important to note whether private individuals or institutions (Table 5.4). leases contain provisions concerning renewals. Table 5.3: Financial Obligations of Transferred Units Number of Units' Obligations from: Czech Republic Poland Hungary Suppliers for Existing Inventory 2 17 6 State Companies 21 10 5 Banks 0 6 (12) 2(6)2 No. of Observationsq __________ 100 100 85 1 Number of units that assumed obligations from an indicated creditor. 2 Two figures are presented for the number of units answering that they assumed obligations to the banks: the number of units reporting in the survey that they assumed bank loans (in parentheses) and the adjusted set of figures. The adjusted figures are based on the presumption that respondents who answered that they assumed obligations to the banks referred to the bank loans used to finance their transfer, rather than to pre-existing obligations. It should be noted that unadjusted figures are used in the analysis of behavioral implications. Number of valid responses, defined as responses indicating that the transferred unit assumed pre-existing obligations from at least one creditor listed in the table. Table 5.4: Owner of Rented (Leased) Premises Percent of Units Category of Owner Czech Republic Poland Hungary Municipality 58 21 61 Housing Coop 13 18 2 Trading/Consumer Coop 0 32 9 State-Owned Enterprise 13 14 9 Private Individual or Company 10 10 17 Other 6 5 2 No. of Observations' 71 72 64 Number of valid responses, defined as responses to one of the listed categories. Eastern European Experience with Privatization 65 5.22. While the number of valid responses is too cerns, very few transfer contracts, whether leases or small for confident generalizations to be made, it sales, have restrictions on change of suppliers or appears that most leases have an option to renew, layoffs of employees. A substantial proportion, but without specifying the conditions of renewal however, have restrictions on the change of line of (including price), and only a small proportion of business or on subletting and resale (see Table 5.6). leases contain purchase options. Except in Hun- 5.24. The restriction on the change of line of gary, the latter usually also fail to specify the terms business is probably due to the fear on the part of of the purchase. the authorities that too rapid changes would lead to disruptions of supply. Restrictions 5.25. The restrictions on subletting and resale of the premises clearly impede the operation of sec- 5.23. In line with the fact that most transfers ondary markets and, therefore, impede improve- concern premises rather than going business con- ments in the original allocation. What makes these Table 5.5: Duration of Rental (Lease) Contracts for Premises Percentage of Units Czech Republic Poland Hungary One Year 0 22 3 Two Years 33 20 3 Three Years 2 10 6 Four Years 2 0 0 Five Years 55 37 32 Longer than Five Years 8 11 56 Average Duration (Years) 4 4 7 Median Duration (Years) 3 3 10 Number of Observations' 69 40 34 Number of valid responses, defined as responses indicating durations greater than zero. Table 5.6: Duration of Restrictions in the Transfer Contract Average Number of Months (during which restriction applies) Type of Restriction Czech Republic Poland Hungary Business Cannot Be Closed Down' .. 7 12 Employees Cannot Be Laid Off .. 12 1 Business Cannot Be Closed or Sublet 60 47 66 Line of Business Cannot Be Changed 27 47 60 Supplier Relationships Cannot Be Changed .. 60 65 Proportion of Contracts with Restactions on Activities 28 41 52 Number of Observations' 100 100 99 Restrictions specified by duration are measured in months. Numbers in the table contain averages across units reporting that they are subject to an indicated restriction. I Number of valid responses, defined as responses indicating durations greater than zero. 66 Eastern European Experience with Privatization restrictions even more burdensome is that their Auction refers to an open bidding procedure in length is approximately equal to the average length which both insiders and outsiders can participate. of the rental contracts in our sample, and in the case Closed tender refers to directly negotiated trans- of the Czech Republic even exceeds it. fers of premises in which outsiders are not in- 5.26. The survey permits gauging to some extent volved and more than one insider is bidding for the degree to which the restrictions contained in the property. leases and sale contracts are in fact enforced by the Coe on es fr e auhrte an copldwt ytersodns Closed non-competitive transfer refers to directly authorities and complied with by the respondents. To begin with, a number of people who had some negotiated transfers of premises in which outsid- restrictions in their contracts (especially in the ers are not involved and only one insider is Czech Republic) stated that they were not en- bidding for the property. forced, although most said they were not easy to Open procedure refers to an auction or an open evade. More significantly, there is a striking differ- tender. ence in the behavior of people with restrictions of Closed procedure refers to a closed tender or a short duration and restrictions of long duration: closed non-competitive transfer. while those who are barred from changing the line Competitive transfer or procedure refers to all of business for a period of less than 50 months forms of transfers except closed non-competi- usually comply with their contracts, the proportion tive transfers. ofunits with long-term restrictions (over 50 months) which change the line of business is the same as 5.29. Thesizeofthesampleinoursurveydoes not among the units with no restrictions at all. permit drawing conclusions concerning the degree of competitiveness in all types of transactions. But Competitiveness of the Transfer Process the results give a fairly adequate picture for the transfer of those units that were leased (rather than 5.27. Much discussion of small privatization fo- sold). In that regard, the competitiveness varied cuses around the advisability of using competitive substantially across the three countries: in the Czech procedures (open auctions or tenders) as opposed Republic, 99 percent were by competitive means, to directly negotiated transfers which are likely to in Hungary, 54 percent, and in Poland, 29 percent favor insiders and which have the potential for (Figure 5.1). breeding corruption and favoritism. On the other hand, competitive procedures may be very threaten- Publicity for the Transfer ing to insiders in the units subject to privatization. 5.28. The discussion in Chapter I of this report 5.30. The publicity for the transfer is a vety im- showed the modes of transfer among the three portant feature of small privatization, especially if countries, distinguishing auction, direct sale, and participation of outsiders is considered essential. directly negotiated rental (see Figure 1.5 in Chap- The survey asked how each respondent learned - - about the availability of the unit, and many re- ter I). However, this distinction does not give the full picture of the competitiveness of the process. sponses indicated multiple sources of information One may perhaps ignore the fact that not all (advertisementinthemedia,governmentannounce- auctions generate more than one offer,' since once ment, acquaintances, and internal announcement). the process is open to all (insider and outsider) To assess the importance of the various modes of participants, one may consider it "competitive." announcement, the following ranking was estab- lished: "advertisement in the media" was counted But many of the negotiated transfers may be comn- only if it was listed as the sole mode of announce- petitive as well, either because outsiders are in- volved in the negotiations or because more than ment; government announcement was counted - . . .only if the respondent listed it and did not list one insider is bidding for the property. In order to o capture these distinctions the following terminol- internal announcement" or "acquaintances" as ogy will be adopted in the subsequent discussions: the Source ofinformation; and "acquaintances" was counted only if "internal announcement" was not Open tender refers to directly negotiated trans- listed. The purpose of the ranking was to bring out Fers of premises in which outsiders (individuals the degree ofpublicity accompanying each particu- not previously connected with the unit) are lar transfer, with the most public form of an- involved in the competition for thesale orrental. nouncement, presented in Figure 5.2, treated as Eastern European Experience with Privatization 67 Figure 5.1: Mode of Transfer of Rental Contracts for Premises' Czech Republic Closed Non-Competitive Open Tender (200) Transfer (1) Poland Auction Open Tender (22%) 7%) Closed Non-Competitive Transfer (23%) Auction (970) Hungary Open Tender (9%) Auct ion Closed Tender (48%) Closed Tender (24'.) Closed Non-Competitive Transfer 12200) 'Number of Observations: Czech Republic-72; Poland-69: Hungary-56. Source: Survey Figure 5.2: Sources of Information About Transfers' (Pooled Data) All Respondents internal Announcement Acquaintances (15%) to Employees 320o Advertisement in the Media (181) Owners or Co-Owners/Former Insiders Govemment Announcement r3501 Internal Acquaintances I8) Advertisement Announcement - In the Media (401) to Employees (55,) Owners or Co-Owners/Former Outsiders Goverm ent Announcement Internal (330) Announcement Acquaintances i90) to Employe Advertisement (2210 in the Media 2(26.) Government Announcement 43'01 No. of Observations: All Respondents-268, Owners or Co-Owners/Former Insiders-39; Owners or Co-Owners/Former Outsiders-120. Source: Survey. 68 Eastern European Experience with Privatization characteristic for that transfer. In particular, this were also higher than the proportions of purchases ranking focused on the marginal efficacy of the in the sample, which indicates that a significant announcement in the media, and allowed an estimate proportion of rentalcontracts required collateral as of how many of the present owners would not have well. The most commonly used form of collateral participated in the transfer process if no media adver- was the owner's real estate (49 percent of transfers), tisement had been made. Among the outsider owners, it followed by the asset itself (23 percent of transfers), is estimated that26percent would not haveparticipated and third-party guarantees (11 percent of trans- had it not beenfr the announcement ih the media. fers-used most often by insiders). Fi n . . . .5.32. The data show a surprising degree of avail- ability of bank financing for the acquisition of the 5.31. Owners of approximately 59 percent of premises of the privatized units. While personal units in the sample had to make an initial payment savings and loans from family and friends are the for the purchase or rental of the premises. In a mainsourcesoffinancing,bankfinancingisusedin significant proportion of cases in each country a significant proportion of cases in the Czech some form of collateral was required in the transfer Republic, Poland, and Hungary, especially when contract. It is worthy of note that these proportions purchases, rather than leases, are involved (Figure 5.3) Figure 5.3: Financing of the Transfer Contracts for Premises Czech Repubic 83% S80 65% N= 24 N=29 N= 24 N=29 Personal Savings/ Bank Financing Friends and Family Poland 100- 83% 80- 60. ss% 40- N= 34 N=4 N=34 N=14 Personal Savings/ Bank Financing Fnends and Family 100. Hungary 80- C4 61% 60- % 40- 37 20 N denotes sample size. NV= 32 N= 14 N= 32 N=14 Personal Savings/ Bank Financing Friends and Family W Leases O Purchases Source: Survey. Eastern European Experience with Privatization 69 E. Post-Transfer Behavior and Environment the region, where resistance to the reform of the wholesale sector may be stronger and change may 5.33. The post-privatization behavior ofthe trans- be slower in coming. ferred units may be thought of as dependent on 5.36. Having said this, it should be added that the three basic factors: the environmental constraints survey is not without implications for the debate on faced by the units, the effects of the transfer process, the relative priorities of the reform in the retail and and the post-transfer ownership structure. In this wholesale sectors. In fact, it provides some evidence section, we will provide a picture of the environ- for both points of view, although the evidence for mental conditions in which the privatized units the "upstream push" through the reform of the retail operate. sector is somewhat more direct and perhaps stronger. 5.37. The strongest evidence for the existence of Quality and Choice ofSuppliers an "upstream push" can be seen in Figure 5.4, which reports the proportions ofsupplies delivered 5.34. The relationship between a revitalization of to the retail units in the sample through various the retail sector in consumer trade and the reform means of transportation. of the wholesale sector is an often-debated "chicken- 5.38. The most striking feature of the figure is the or-egg" problem. According to one point of view, high proportion ofsupplies delivered by own trucks/ the rapid privatization of the retail sector is bound vehicles, which reaches 65 percent in Poland, which to produce dramatic changes in demand in the indicaces that private retailers can organize a very wholesale sector and induce necessary upstream effective substitute for a functioning system of restructuring. According to another point of view, wholesaling (depending, ofcourse, on theavailabil- however, the reform of the retail sector has a very iry of transport). In Poland many state enterprises, low plateau of possible improvement in the supply in the wake of tightening budget constraints, sold of goods to the population unless the wholesale off part of their stock of trucks to private individu- sector is previously, or at least simultaneously, als; this increase in supply led to a rapid expansion demonopolized and made to perform at a higher of the new private wholesale sector. While we have level of efficiency. no information on the source of the large number 5.35. The survey contains only limited informa- of private trucks in use in Hungary and the Czech tion bearingon this issue. It should be noted, however, Republic, the proportions of own trucks indicates as a caveat to our description of the changes in the that the very fact of "upstream demand" may be a retail area, that the process of reform in all three significant factor in generating increased supply. countries examined has proceeded simultaneously 5.39. With unconstrained choice, retailer percep- in the retail and the wholesale sectors. For this tions of the quality of various sources of supply reason, some of the results detected in the sample drive the shifts from one source to another. It was may not be easily reproducible in other countries of important, therefore to examine the way in which Figure 5.4: Mode of Transport Used for Supplies' 100 - so 80 - 40 (36FO (39%) ( 230 )27%) (24%) (28%.) Czech Republic Poland Hungary U Own TrucksVehicles O] Pnvale Wholesalers E Siate Sources Nurnber of Observations: Czech Republic-98; Poland-100; Hungary-97. Source: Survey. 70 Eastern European Experience with Privatization retailers in the three countries viewed the relative the wholesale sector is probably a contributing merits and demerits of the private and state suppli- factor as well. ers. For this purpose, respondents in each country 5.45. Equally striking is the minor role played by were asked to evaluate each source of supplies the banking system in the financing of long-term (state, cooperative, and private) along six dimen- investments. The Czech Republic is theweakest on sions: price, timeliness, assortment of goods, qual- this score, with only 9 percent of investments ity of goods, terms of payment, and extension of financed by the banks. The figures are only slightly supplier credit. Each supplier could be ranked as higher for Hungary (18 percent) and Poland (26 "best" or "worst" on each dimension. percent). Not surprisingly, bank financing ofwork- 5.40. In all three countries, the respondents as a ing capital is even more limited, at 4 percent in the group nearly uniformly ranked private suppliers Czech Republic and 11 percent in Hungary and above the state ones in all dimensions - only in Poland. one case and in one dimension (extension of credit 5.46. The scarcity of bank financing for invest- in the Czech Republic) were state suppliers ranked ment appears to be one of the important factors significantly higher than private ones. The rankings affecting investment levels and ownership structure of private suppliers become even higher when only of small businesses in the area. Where financing is previous outsiders are polled, which points to the unavailable and individual wealth is small, indi- slower pace at which the old managers in the state viduals wishing to expand their businesses must sector change their minds. turn to other equity contributors and change the 5.41. Some of the highest ratings of private sup- structure of ownership of their businesses. This pliers were noted in Hungary. Yet Hungary is the effect is very pronounced in our sample, where country with the lowest proportion of supplies partnerships in Poland and Hungary' invested sig- provided by the private sector. The reasons for this nificantly more in the remodeling of their units can only be conjectured, but this phenomenon following privatization: while individual owners might support the "downstream drag" view of the invested, on the average, $4,199, partnerships in- relationship between retail and wholesale sectors: vested $6,349. The difference is still more pro- the Hungarian wholesale sector may still be domi- nouncedwhen only outsider owners areconsidered; nated by large state suppliers that enjoy local mo- the sample mean of investment for partnerships nopolies in some areas, and many retailers may have then skyrockets to $8,224. At the same time, part- to use them regardless of the quality of their set- nerships formed by insiders show even lower levels vices. of post-transfer investment ($3,124), probably be- 5.42. Overall, however, retailers in all three coun- cause their formation was motivated more by the tries have moved decisively away from state suppli- need to share preferential acquisition terms than by ers. The change is particularly pronounced in the the need to pool investment resources. Czech Republic and Poland. Employment Patterns Financing of Operations 5.47. It is interesting to note that in both Hun- 5.43. The most striking feature of the data on gary and the Czech Republic the average employ- post-privatization financing in the survey is that ment perunit in the sector is growing, but this is not credit from suppliers is virtually unavailable for the case in Poland, where the number of managerial financing working capital.' Supplier credit is the and non-managerial employees is slightly smaller usual mode of financing retail businesses in mature than it was at the time of transfer (see Figure 5.5 ). economies, since monitoring small businesses is 5.48. A strong increase in the ratio of managerial too costly for banks and other creditors in relation to non-managerial compensation, observable in all to the size of the loan. Suppliers, on the other hand, countries and reported in Table 5.7, should be because of their ongoing relation with the retailers, taken as positive evidence of post-privatization are in a better position to oversee retailers' activities. restructuring. Given the relatively flat compensa- 5.44. The absence of supplier credit in Eastern tion curve characteristic of the old system, the Europe is most likely due to high interest rates change is likely to result in a significant modifica- coupled with the newness and transitional state of tion of managerial incentives. many of the relationships between suppliers and 5.49. The survey also provides information on the new owners of retail establishments. The turmoil in face of former managers and employees. The num- Eastern European Experience with Privatization 71 Figure 5.5: Average Employment (Per Unit) 2- Managers 1.6- 1.41 1.44 1.2- 1.14 1.15 1.09 1.00 0.8- 0.4- 0- 1 N=90 N=99 N=99 N=100 N=100 Czech Republic Poland Hungary 10- Non-Managerial Employees 9- 8.7 8- 7.12 7- 6 - 5.3 5- 4.84 4.75 4.4 L 4- 3- 2- 0 N=90 N=99 N=99 N=100 N=100 Czech Republic Poland Hungary U At the Time of Transfer O At End-1992 N denotes sample size. Source: Survey. Table 5.7: Ratio of Managerial to Non-Managerial Compensation Percent of Units Change of Ratio of Managerial to Non-Managerial Compensation Czech Republic Poland Hungary Large Increase Since Transfer 13 5 3 Moderate Increase 23 34 18 Unchanged 48 39 50 Moderate Decrease 1 7 7 Large Decrease 0 0 0 No. of Observations' 100 100 96 1 Number of valid responses, defined as responses to at least one of the listed categories. 72 Eastern European Experience with Privatization ber of former managers who are Fired after the Perceptions of the Environment and the Role of transfer varies considerably by country. As is shown Government in Figure 5.6, the Czechs, both insiders and outsid- ers, are much more likely to fire former managers, 5.50. The respondents' perceptions of the con- and the outsiders are particularly brutal in applying straints imposed on them by the environment in the axe. By contrast, in Poland, even in units taken which they work (see Table 5.8) confirm some of over by outsiders, the rate of retention of previous the analyses in the previous sections of this survey managers is relatively high.' and raise other interesting issues. Figure 5.6: Average Number of Former Managers Employed (At time of Survey) 1.5 - 1.14 1.15 1.09 1 03 CL 0.86 0.79 0.68 U At Time of Transfer 0.49 05 04O Units Owned by a Former Manager 0.36 U Units Owned by a Former Outsider 0 - - - -N denotes sample size. N=97 N=99 N=98 Czech Republic Poland Hungary Source: Survey. Table 5.8: Perceived Work Environment Constraints Perceived Constraint (Number of Respondents)' Type of Constraint Czech Republic Poland Hungary Strong Competition 13 50 50 Government Regulations and Interference 54 10 51 Poor Quality of Existing Workforce 15 8 13 Shortage of Labor 11 4 12 High Cost or Lack of Credit 83 74 77 Limited Availability of Supplies 23 4 16 Problems with Delivery of Supplies 22 4 11 Inflation or Price Stability 58 83 78 Lack of Demand 25 65 59 Lack of Foreign Exchange 0 4 2 Political Stability 11 26 19 Corrupt Government Officials 14 13 8 Difficult Bureaucratic Procedures 53 24 44 Lack of Procedures to Enforce Contracts with Customers and Suppliers 11 7 7 Legal Uncertainty 31 64 30 1 Number of respondents listing a given constraint as a critical one affecting their operations. Eastern European Experience with Privatization 73 5.51. The two most significant constraints per- privatization restructuring appeared as a sensible ceived by the respondents in all three countries procedure. were clearly lack of available credit, and inflation 5.55. The sample means of the levels of invest- (which could also be related to the high interest ment in remodeling in U.S. dollars' in each of the rates of financing). It is interesting to note that three countries are $4,390 for the Czech Republic, strong competition and the lack of demand for $4,156 for Poland, and $6,017 for Hungary, and goods are serious concerns in Poland and Hungary, the average for all respondents is $4,835. while they appear much less important in the Czech Republic, where the sector may not yet be fully Debt and Its Impact on Investment developed. 5.52. The respondents evidently do not see gov- 5.56. One of the decisions to be made in the ernment corruption or political instability as very context of small privatization is whether units in important factors, but both the Czechs and the the sector should be liquidated and their assets sold Hungarians worry about governmental interfer- to private parties, or whether they should be ence and bureaucratic obstacles (both of which privatized as a going concern. One of the argu- seem to be relatively minor concerns to the Poles). ments against privatization of going concerns is Contrary to the concern of many Westerners, the that saddling new owners with the obligations of respondents do not seem to be very worried by old state businesses may interfere with their restruc- difficulties with contract enforcement, but they do turing efforts. worry quite a lot (especially in Poland) about "legal 5.57. The survey has not yielded conclusive re- uncertainty," by which they most probably mean sults concerning the impact of indebtedness at the the insecurity of property entitlements. time of transfer. Although the sample mean of investment for units with no financial obligations F. Behavioral Implications of the Transfer ($5,065) is higher than that for the indebted units Contract ($4,109), the difference is not statistically signifi- cant. 5.53. This section and the next two sections (sec- tions G and H) will focus on the effect of various Impacts of Contract Uncertainty and Lease features of the transfer process and post-privatiza- Restrictions tion ownership structure on the behavior of the privatized units following the transfer. The study 5.58. Another important feature determining the will be primarily centered around one outcome level of investment is the degree of uncertainty of variable - the level of investment in the wake of the title to the most important assets of the busi- privatization ness: the premises. When the pooled sample for all three countries is considered, the respondents have a Levels oflnvestmentandRestructuringin the Sample pronounced preference for outright ownership over lease contracts, and the businesses that own their 5.54. Investment in the remodeling ofpremises in premises show much higher mean levels of post- the wake of privatization is used in this study as a privatization investment (Figure 5.7).'o Even an proxy for long-term investment in the unit. The option to purchase raises the mean level of invest- physical stock of the consumer trade and service ment in our sample, but this result is not statisti- outlets under the old regime was rundown and cally significant. woefully inadequate to satisfy the needs of the 5.59. There are several possible explanations of population. While the elimination ofshortages and the preference for purchases over leases. One is the the increase in the assortment of goods was the tenant's weak bargaining position vis-a-vis the land- most pressing need in countries such as Poland, a lord, who is often a municipality or a powerful state sizable investment in the remodeling of the pre- institution, frequently with a near monopoly on mises, improving their appearance and functional- the real estate of a given kind. In this situation, the ity, and furnishing them in accordance with the new tenants might well fear that the landlords standards customary in Western countries was nec- might use their market position to extract all types essary to bring the consumer retail and services of unexpected concessions. sector up to par. Therefore, using the level of 5.60. But there may also be another explanation: investment in remodeling as a proxy for post- namely, the fact that rentals, especially in Poland 74 Eastern European Experience with Privatization and the Czech Republic, are usually of very short the privatized units (in terms of investment levels, duration (a sample mean of four years, with a large adaptation to new market conditions, improve- number under two years). Indeed, a closer exami- ment of assortment and service, etc.). nation of our sample reveals that the preference for 5.63. Open procedures (auctions and open ten- purchase over leases is very pronounced in Poland ders), when looked at only from the point of view and the Czech Republic, but not in Hungarv, of whether they result in a better allocation of the where the average length of rental is seven years. privatized units, seem to be significantly preferable 5.61. Independentevidenceinchestudvalsoshows to transfers with no outsider participation (closed that contract duration is one of the crucial driving procedures), since, as is shown in Figure 5.8, invest- Ibrces of post-privatization investment' units with ment in units transfrrred through open procedures is, leases with terms longer than five years had, on the on the average, significantly higher. average, more than double the investment rate of units with leases shorter than Five years: $5,272 H. Behavioral Implications of Post-privatization versus $2,687. Ownership Structure G.BehaviorallmplicationsoftheCompetitiveness 5.64. As is shown in Figure 5.9, outsiders, on the of the Mode of Transfer average, invest much more than insiders. Moreover, the effect of the ownership structure persists regard- 5.62. Perhaps the most frequently debated issue, less of the method of transfer, so long as outsiders and one of the most important questions for are allowed to participate at all. policymakers, in the context of small privatization 5.65. The superiority of outside owners is not is whether granting preferences to former employ- surprising. To begin with, outsiders, being a self- ees in the acquisition of the privatized units ad- selected group of entrepreneurs, probably have versely affects the behavior of the those units in the more capital than do former employees in what was wake of the transfer. This issue can be broken down traditionally a low-paying sector in Eastern Euro- into two related problems: (1) whether a competi- pean economies. Also, outsiders are less likely to be tive transfer process allocates the privatized units to set in the old ways ofdoing business, and this makes significantly more effective new owners, and (2) it more likely that they will institute changes that whether insiders are less effective in restructuring will lead to a greater amount of remodeling. Figure 5.7: Effects of Contract Uncertainty on Investment in Remodeling of Premises (Pooled Data) $10.000 - $8,000 - 6,470 S6.000 -4,5 4,950 4,308 3,949 S4 000 - $2.000 N=38 N=117 N=1 N=34 N denotes sample size. Outright Rental Rental/Option Rental/Option Purchase to Purchase to Renew Tests of the differences between the following Means of Investment (MINV): MINV (Outrght Purchase) > MINV (Rental); P-Value = 3% MINV (Rentai:Cpton lo Purchase) = MINV (Rental,Option to Renewt Source: Survey. Eastern European Experience with Privatization 75 5.66. In addition, the survey results were used in short dUration and post-privatization ownership a simple multivariate analysis of the relationship arrangements turned our to be insignificant." between investment in remodeling of premises and 5.6-. Even after the effect of duration on invest- duration and post-privatization ownership arrange- icnt is controlled for, and despite the finding that ments, as well as other factors considered in this and outsiders' rental contracts have longer durations, the previous sections: mode of transfer, price ratios, the effect of outsider ownership on investment in purchasesversus rentals, country-specific dummies, remodeling of premises following privatization re- etc. All variables except the variables for long and mains significant. Figure 5.8: Competitiveness of the Transfer Process and Investment in Remodeling of Premises (Pooled Data) $5,000 $4,000 $3,000 $2,000 $1,000 so Open Closed Procedure Procedure N=78 N=95 N denotes sample size. Test of the difference between the following Means of nvestment (MINV)i MINV (Open Procedure) > MINV (Closed Procedure). P-Value 5`6 Source: Survey. Figure 5.9: Outsider and Insider Investment in Remodeling of Premises (Pooled Data) $5,000 4,943 3,862 $3,000 9 Former Outsider S2,000 2,683 2,632 O Former insicer $1,000 so Sole Owner or Co-O,,,er Sole Owner N=39 N=J N=34 N=30 N denotes sample size. Tests of the dfferences netweer the following Means o Investment (MINV): MINV iSole Owner o. Cc-Owner Outsider) > M1 i Soe Owner or Co-OwnerInsider). P-Value = 5% MINV ISole Oner Ousider > MINV iSole Owner Ins cer P-Value= 7% Source: Survey. 76 _Eastern European Experience with Privatization Notes the overall changes in employment in the sector; in fact, the number of units in all countries grew exponentially in the 1. This chapter is taken from a more detailed joint study of the wake of the reforms, and the consumer sector represents Central European University Privatization Project and the one of the few dynamic areas of growth in the three World Bank. economies. 2. Classification was based on the activity from which the 8. While the retention rate of former managers in Poland has business derived more than 50 percent of its revenue. Food been high, the survey contains evidence that overall labor stores were defined to include stores selling both fresh and turnover in Poland has also been very high, with 43 percent processed foods. A "store" was defined as a business unit of managers and 76 percent of non-managerial employees with a window located in a permanent structure; thus it was fired since the transfer. This may be considered as evidence distinguishable from kiosks, street vendors, and other types of restructuring and perhaps also as an indication of a shift of commercial outlets. A "household necessity store" was in power from the workers to the managers. defined as a store selling non-durable household goods. 9. The following exchange rates were used in this study: Kc "Restaurants" were defined to include all catering estab- 28 = $1, Ft 75 = $1, ZI 13,000 = $1. lishmentsservingfood. Excludedfrom "serviceunits"were 10."N" in this and other figures denotes the sample size. all businesses providing services such as law or accounting About 25 percent of the respondents did not report the offices. levels of investment in their units. The units with missing 3. Some units had confused the debts of previous establish- observations were excluded from the sample. ments with debts to finance the transfer. After correcting l1 .The estimated regression model, retaining only significant for this confusion, it appears that no more than 18 percent variables for the sample of rentals, is as follows: of the units in all three countries assumed any obligations INVESTMENT IN REMODELING OF PREMISES of the pre-existing state or cooperative establishments. 4. In fact, 25.7 percent of auctions in our pooled sample did (.0436)(.0416) (.007) not generate more than one offer. It should be noted that the number ofoffers is dependent notonlyon the openness where, of the process, but also on how high the starting price is. DURX = 1, if duration > 5 Thus, For example, in the Hungarian sample, heavily = 2, if duration <=5 skewed by the proportion of units in the Preprivatization Program, in which starting prices were set relatively high, SMSO = 1, if the establishment is solely owned by its over 44 percent oftransfers did not generate more than one former manager offer, even though the process was quite open and resulted = 2, if the establishment is solely owned by a in the highest proportion of outsider-owners among all former outsider. three countries. 5. In the Czech sample none ofthe working capital is reported As is clear from the p-values (noted in parentheses under as financed by suppliers, while the figures for Hungary and the coefficients), both dummy variables are highly signifi- Poland are 5 and 7 percent, respectively. cant. Regarding DURX, since the relationship between 6. There were no partnerships in the Czech Republic sample. duration and investment appears to be nonlinear, this 7. The changes over time in the average number ofemployees dummy variable was used to estimate approximate effects per unit should not, however, be taken as an indication of of long- and short-term leases.