Privatization: Lessons from Russia and China
edited by Joseph Prokopenko
CONTENTS
INTRODUCTION
1. COMPARISONS OF PRIVATIZATION RESULTS: AN OVERVIEW by Joseph Prokopenko
1.1 The main results of Russia's "quick" privatization
1.2 Some problems of privatization and corporate governance
1.3 Clear property rights are of critical importance
1.4 Urgent need for faster market institution development
1.5 The Chinese "gradualist" approach
1.6 China also has urgent problems
1.7 Some considerations for the future
1.8 Comparisons between Russia and China. Rapid or gradual reforms?
2. PROBLEMS OF OWNERSHIP AND PRIVATIZATION IN RUSSIA by Alexander Letenko and Dmitry Lvov
2.1 Introduction
2.2 Evolution of methods and approaches to privatization
2.3 The legal principles of privatization in Russia
2.4 Initial assessment of the results of privatization
2.5 The trade unions and privatization
2.6 The trade union alternative to present privatization practices
2.7 Possible dead-ends of privatization and the ways out
3. THE DEVELOPMENT OF THE NON-STATE-OWNED ENTERPRISES AND ITS IMPACT ON ECONOMIC REFORM: THE CHINESE EXPERIENCE
by Wei Wang
3.1 A historical review: the economic system before 1978
3.2 The emergence and development of non-state enterprises
3.3 Case analysis
3.4 Conclusion
Literature
Until now, no transition economy has succeeded in its transformation efforts without adhering to the above set of reforms. Many examples demonstrate that the main reasons for difficulty or failure lie in ignorance of this set of reforms as a balanced and integrated process.
The main purpose of this paper is to consider two reform cases - Russia and China - both of which experienced successes, difficulties and failures for various reasons. One of the main questions arising in such studies is, could the countries learn from one another, or could other countries learn from the lessons of these two countries? There are two major and extreme views on the usefulness of comparing the experiences of China and Russia. The first view is that it is absolutely useless, and the second view is that these experiences are easily transferable. Should the second view be right, who should learn from whom? China from Russia, or Russia from China? Or perhaps third party countries should learn from both Russia and China.
We do not share either of these extreme views. Our opinion lies somewhere in between (where exactly is yet unclear and more research and further practical experience of these countries in the future will clarify things). What is important at this stage is to demonstrate that there is a great deal to learn from the countries' comparative experiences in both policy and implementation approaches. Despite specific local historical, economic and political conditions, reform leaders make choices on strategy and policy mechanisms and their mistakes could have dramatic consequences on the long-term results of the reforms.
Both Russia and China have made profound progress in their reforms, with both positive and negative results. The first chapter concentrates on analysing some important consequences of privatization, including social ones, in both countries. We believe this is much more important than the percentage of privatized state enterprises. The final decision on which country has done better socially in its transition efforts is left to the readers as well as to the population of these countries, and they will use their own criteria for comparison. This paper tries to provide some arguments and objective information on which to base these conclusions.
Our analysis is based on the assessment of two case studies provided in Chapter 2 (Russia) and Chapter 3 (China), as well as other broadly available published and unpublished sources as well as personal experience. The Russian case provides an excellent overview of the reform policies, their implementation and the results. It also covers the opinions of different population groups in Russia, including trade unions, though its general bias tends to be a bit negative and tends to ignore some evident positive reform achievements. In contrast, the Chinese case concentrates mainly on the enterprise level and provides what is perhaps too bright a picture whilst ignoring some serious problems, particularly in the financial and management fields. Some key factors contributing to the growth of new forms of ownership are also missing.
Naturally the reader may agree or disagree with some of the authors' opinions. This paper is intended to provoke further discussion rather than provide definite answers, and the expressed views by the authors are not necessarily those of the ILO.
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I would also like to acknowledge the contributions of the other authors of this paper. Dr. Dmitry Lvov, Academician, Secretary of the Economic Branch of the Russian Academy of Sciences; Dr. Alexander Letenko, Senior Researcher at the Central Economics-Mathematics Institute (CEMI), Russia; and Ms. Wei Wang, Senior Researcher and Programme Manager at the Institute of World Economics and Politics of the Chinese Academy of Social Sciences; and all those who helped them in their research. I would also like to thank my colleagues in the Entrepreneurship and Management Development Branch who have commented on this paper which was prepared within the framework of the Interdepartmental Action Programme on Privatization, Restructuring and Economic Democracy.
Joseph Prokopenko
Head, Research and Programme Development Section
Entrepreneurship and Management Development Branch
Though industrial production increased in the first half of 1997 by 0.8 per cent as compared to the same period in 1996, the volume of domestic investment declined by 9 per cent due to drastic cuts in federal investment programmes, high interest rates for banking credits, and the higher returns possible from short-term state securities. Estimates suggest that about US$65 billion have left the country since 1992. Eighty per cent of peoples' savings are held in dollars and are generally not deposited with national banks or invested. The privatization process and redistribution of property is giving rise to clashes between the major financial and industrial groups and is often accompanied by political scandals.
The general situation in the social and labour areas also remains very difficult. About 20 per cent of the population have incomes below the minimum subsistence level (about US$72). The gap between rich and poor seems to be widening with the top 10 per cent of the population increasing its share of national income from 30 per cent in the first half of 1996 to 32.2 per cent in the first half of 1997. The average pension (US$55) and the average wage (US$167) remains very low. By May 1997 the standard of living of the average Russian was only half that in December 1991. According to the Ministry of Labour, at least 25 per cent of those employed in the major branches of industry face inadequate occupational safety and health conditions, and in some branches (metal trade, chemistry) this figure exceeds 40 per cent. Life expectancy for women fell from 74 years in 1986-1987 to 71.2 in 1994 and from 64.9 to 57.6 years for men, declines unprecedented in modern history.
The number of those employed decreased from 73.8 million in 1991 to 65.4 million at the end of June 1997 due to declines in large and medium enterprises, especially in machine-building and light industries. Unemployment, according to ILO data, was up from 5.5 per cent in 1993 to 9.5 per cent (6.9 million) early this year, and many economists put the true figure much higher. Approximately four million workers are on administrative leave, and together with part-time workers and those employed short-term, they constitute important "hidden" unemployment.
The results of privatization are closely linked to the privatization approach that was adopted in Russia. The architects of the reform sought to carry out privatization in the minimum time. They failed to give people a chance to first understand and digest the results of the first stage of the reform, including the liberalization of prices which had caused production and consumption to plummet. Some authors believe that had privatization been effected gradually, the people's response to the changing economic situation might have foiled the reform altogether. Another reason for the haste was to make reforms irreversible and create a new class of owners. But as a result, big amounts of capital were amassed in the shadow economy or through speculation, bribes and embezzlement. Persons closely involved in these dealings, such as corrupt officials and well-informed enterprise managers, have therefore come to hold key positions in the economy.
According to estimates by the Ministry of the Interior, 70 - 80 per cent of privatized and private firms and commercial banks are obliged to make payments to criminal gangs, corrupt officials or racketeers. The strong position of the former nomenclature in privatization is apparent from cases where managers misappropriate shareholdings. For example, one channel of privatization concerns the accumulation of individual savings deposits and vouchers by financial institutions in a situation and pattern of property relations that is highly confusing. Hundreds of voucher funds and investment agencies that resemble mutual funds in the West have sprung up to utilize the vouchers of ordinary Russians who lack the confidence to invest in the stock market for themselves. In a number of cases, a fund has proved to be a bogus structure set up by criminal or near criminal elements to take advantage of the lack of state supervision.
Another problem is the difficulty in establishing the boundaries of the private sector. There are at least two reasons for this: first, "official" forms of privatization played a relatively minor role until recently. They served either to legalize property rights already gained "unofficially" or paved the way for further redistribution of property by mass privatization. Secondly, "specific" forms for developing the private sector have been widely practised. These have included not only directly expropriating state property, but also unofficial forms such as legally transferring part of the added value created by state-owned enterprises (SOEs) to the private sector. Financial holding companies, semi-state-owned banks and other financial structures intended to open parallel money and stock markets, and take advantage of debts and credit dependence among enterprises to "trap" debtor industries and force them to privatize their assets by legal or illegal means.
As a result, the entire public sector industry privatized up to now in Russia was sold for only US$12 billion due to this ineffective privatization strategy. Since management and workers were allowed to retain a large percentage of ownership, there has effectively been no change in the management of these organizations, resulting in very poor response from private sectors or foreign investors. Overall, management and workers received 51 per cent of the stocks in privatized SOEs at 1.7 per cent of the book value. Performance of these privatized enterprises has gradually deteriorated since privatization was more political than economic.
Three quarters of Russian corporations are in need of radical and far-reaching restructuring. At least a quarter of those firms should be bankrupt. Although a bankruptcy law exists since 1992, it has never been seriously put into effect (fewer than 1,000 companies have been declared bankrupt).
Russia's one hundred biggest companies have extremely serious problems of corporate governance. Many companies have openly flouted shareholders' rights by issuing free shares to insiders and blocking the appointment of outside directors. Around 17 per cent of companies illegally maintain their own shareholder register, while 44 per cent had bought back and resold their own shares to insiders rather than retiring them. For instance, a group of outside shareholders owing 40 per cent of the stock has been prevented from nominating directors to the board of the Novolipetsk Metallurgical Kombinat.
Nevertheless, the need to privatize is not of equal urgency under all country conditions. Slower privatization is viable if government and the workers themselves are strong enough to keep control of enterprises and prevent managers from diverting assets, and if, as in China, savings and growth in the non-state-sector are high. But privatization is urgent where government is weak and enterprise managers have power, or where restructuring needs reduced available public funds, as in Russia.
The experience of Russia suggests that merging an ownership vacuum with fuzzy property rights lets those in control (usually managers and former nomenclature) appropriate assets or the income they generate (informal privatization). This vacuum delays the restructuring of drifting firms for which nobody is fully responsible. It also creates or prolongs macroeconomic problems because it gives enterprise managers strong incentives to show poor financial performance while diverting enterprise assets and income to their personal possession. To reduce the impact of this, many Russian firms should be shifted from insider to outsider control ("secondary privatization") if they are to attract investors and the management skills necessary in a market economy. Farm reorganization will also require moving from "kolkhoz" (Soviet-style collective farms) to individual property rights to create new viable farms, both individual and real cooperatives.
There are also many proponents of "collective" (but not state) ownership in Russia overemphasizing the role of employee stock ownership plans (ESOP), cooperatives and other similar forms. Certainly these forms are better than SOEs, but it is important to be aware of dead ends in the evolution of ownership: management-employee buyouts of large firms (and ESOP) may entrench managers or employees and block restructuring and further evolution of ownership. World privatization practice indicates that sale to outside investors is more advantageous (the Czech approach) and creates better external shareholder control and active management and also stimulates active trading among institutional investors.
As a result of both positive and negative trends in Russian reforms, a new industrial and financial elite has grown and gained importance. However, a good part of this elite is on the wrong side of development. Heads of leading Soviet-era monopolies, as well as representatives of an aggressive banking and financial community, have accumulated enormous power and wealth, taking advantage of political connections, weak rules, and lack of legislation. Many Russians believe that the concentration of wealth and influence in the hands of a few well-connected industrialists and bankers has discredited reform. This also induced corruption which undermined government authority. Corruption, inefficient taxation, red tape and legal uncertainty are still major problems and barriers to economic reform and privatization in Russia.
The best approach to financial and banking reform for countries with weak state banks and eroded portfolios might be to restrict the activities of state banks while a new parallel private banking system develops. It is also important to accelerate the development of nonbank financial institutions which can finance small and new firms proving central to economic growth. Portfolio and venture capital funds and leasing arrangements are also particularly suited to the transition environment. A capital market, another pillar of an effective financial system, is also essential to raise financing and improve the governance of firms.
For instance, to modernize about 18,000 privatized corporations something between US$150 - 300 billion is necessary (the size of the entire Russian Governmental budget was approximately US$50 billion). This estimate includes only the cost of capital investment and excludes the cost of subsidizing wages and social services. With foreign investment between US$1 and 2 billion a year since the beginning of reforms, privatized corporations represent a capital investment crisis of astounding proportions. The only way to deal with this crisis is to develop strong capital markets - stock markets and bond markets that can efficiently put capital in the hands of these corporations and their lending banks.
The Government itself must also be restructured and reinvented. Reinventing a government in a transition economy means less government involvement in economic production but must not mean a weak government. Around the world high budget deficits often lead to high inflation and slow growth. This is particularly true in Russia. Transition demands far-reaching reforms to make the composition of spending and the structure of taxes necessary to finance it, consistent with the tasks of government conducive to long-term economic growth. But, only six out of 89 regions met their 1996 tax obligations to the federal budget. The main reasons for these tax arrears are falling industrial output and an inefficient fiscal system.
Top priorities in fiscal reform include continuing to improve tax system design by trimming excessive rates and eliminating widespread exemption; making taxpayer registration mandatory; revamping budget preparation procedures; initiating pension reforms; and reducing the large, hidden financial burden on government in the form of tax arrears, government guarantees, state bank losses, or focused credits.
Many problems have also accumulated in the social areas. It is a known fact that a well-educated, healthy workforce is essential to economic growth. In Russia the reform has been associated with deteriorating health. The aim of health sector reforms should be better health and not simply more health care. Reform of education is also urgently needed to address chronic inefficiencies of the old system and to adapt knowledge and skills to the needs of the market economy. The Government must start to extend aid to weak citizens directly through health, welfare, unemployment and training programmes and let firms stand or fall on their own.
Without properly addressing the above problems, Russia risks being mired in a no-man's-land between a centrally-planned system and a fully-functioning market economy. To help economic recovery, besides eliminating legislative and administrative barriers to privatization and foreign investment, government should invest in enterprises on the basis of profit-sharing deals that can provide fast added revenue to the budget or to special off-budget funds, while creating jobs and raising the real income of consumers. These investments should target export-oriented as well as consumer goods industries. A rise in such government investment would not spur serious new inflation. Indeed, fiscal austerity has gone too far and dramatically hampers the promotion of economic growth. The basic change necessary in Russia now is to prioritize growth rather than reform so that recovery can take place as it has in China in this respect.
Urban income has grown rapidly since 1984. Between 1984 and 1993, average household income almost doubled, increasing by 81 per cent with an average annual growth rate of 7.5 per cent. Between 1990 and 1993 the rate of absolute poverty in urban areas fell below 0.1 per cent.
In the early stages of reform inequality also lessened although it increased again in recent years. However, in comparison with other developing countries, rural inequality in China has not been severe. The gradual liberalization of agricultural prices has helped reduce inflationary pressure. The time lag between rural and urban reforms (about six years) spared farmers from soaring agricultural input prices (in Russia the approach and results were exactly the opposite) and provided them with a precious adjustment period. China's rural industrialization also helped to absorb surplus labour force while it increased rural output, created a basis for future rural development, and helped avoid massive migration to the cities.
Gradual urban reform increased income and maintained relative equality while gradual price reform prevented inflationary income erosion. The slow withdrawal of food subsidies eased the pain of transition for the urban poor, prevented the rise of absolute poverty and stemmed widening of inequality. The same could be said about the approach in reforming SOEs. Gradualism helped maintain almost full employment and a steady increase of income, thus helping to avoid massive urban unemployment and poverty.
The acceptance to switch to a "de facto" market economy was confirmed at the Third Plenum of the Central Committee of the Chinese Communist Party (CCP) in November 1993. The following changes extended a sequential development that began with predominant economic planning and subordinate markets in the first phase of reform (1979-84), the combination of economic planning and market regulation in the second phase (1985-88), and government's regulation of the market and market-guiding enterprises (in 1988-91). The economy has now progressed to being a dominant "socialist market economy" in its current phase (September 1997).
"Shock therapy" in Russia and Eastern Europe fuelled inflation, crushed the countries' industries and left people worse off. By contrast, China has seen rapid growth, low inflation and a tide of prosperity that lifted nearly everyone. An outbreak of inflation has been brought under control without much change. China devaluated at its own initiative in early 1994 and its currency is reaping the benefits in booming exports. Double-digit growth seems likely both this year and next, with inflation holding at 5 per cent or less.
It is interesting to trace how enterprise reform influenced institutional changes in China. Enterprise reform started with a series of modifications of existing programmes. While these modifications were designed to maintain the basic rules of the game, they induced different behaviour and expectations from organizations and individual entrepreneurs whose response had intentional and unintentional positive effects on the progress of the reform. Since the beginning of reform in 1978, results have not been impressive because they typically encompass only minor system adjustments without altering fundamental ideas and institutions. The process did not follow the classical sequence of transition - changing the fiscal and monetary system before launching enterprise reform. Changing incentives through the household and enterprise contracting system was a step in the right direction.
In the sphere of institutional change, gradualism may be the only way in which a reform can be successfully carried out in China without bringing about total system breakdown. As fundamental rules that form the incentive structure of society, inturn constituting the underlying determinants of economic performance, most components of an institutional system are not questioned at any given time. Rather, they are accepted and taken for granted because they provide the unifying bond holding society together. Institutions however do change when both formal and informal constraints initiated by the state and individual actors alter.
When enterprise reform was launched in 1984, there was no intention of changing either the guiding ideology or the institutional structure of the planned economy. The main objective was to provide incentives for enterprises and individuals to be more effective through profit retention, the dual-price system and the contract responsibility system. All these measures were designed to reduce price distortion, increase competition and reap the profit generated by free markets. By the early 1990s, over half of the inputs and outputs of SOEs was purchased and sold on the free market. In 1996 mandatory plans controlled less then 10 per cent of industrial outputs. Private enterprises expanded to make up 13.5 per cent of the economy, and joint-ventures accounted for 38 per cent, while state-run production dwindled to 48 per cent. China has not only joined the world global community but has become the globe's third largest economy. China amassed nearly US$40 billion in capital from abroad in 1996 and lures more foreign investment than any other developing nation. The country is already a formidable force in international trade, ranking 11th in the world by export volume.
A disengagement of enterprise finances from the fiscal budget and the division of enterprise property into two components, ownership and control (redistributing the latter without formally conceding the former), were the goals of enterprise reform in China. The positive impacts of these changes were increased enterprise control of wages and benefits, expanded market activity, changes in investment patterns, and more importantly, increased competition.
At the beginning of the 1980s, the main barriers to Chinese economic development were seen as bureaucratic rigidity, inefficiency, and the irrationality of central planning. The reform was not meant to change the fundamental rules of the game but merely to provide more incentives for enterprises to maximize their profits and increase their efficiency. It was not anticipated that when price liberalization would be undertaken, that fundamental structural changes would also take place, i.e. the allocation of resources would no longer be dominated by the state. The command and control system was fundamentally dismantled and the reform took on a life of its own; it was not foreseen by the original designers and that this would require further change in government policies to accommodate such an evolution. The wide gap between intentions and outcomes imposed pressures on the existing institutional structures and demanded further institutional adjustment.
Granting SOEs more autonomy without separating ownership and managerial rights seemed to improve productivity and economic growth but simultaneously triggered social and economic ills which devastated the reform and the economy as a whole. These undesired outcomes (corruption, increased predatory activities, inflation, near bankruptcy of the state, etc.) have become the main stimulus for further reform in China since 1993.
The continuing falls in profit rates throughout industry, coupled with the expansion of enterprise claims on profit flows, caused government, the chief holder of industrial capital, to suffer a crushing decline in revenue from SOEs. From 60 per cent of total revenue in 1978 to 42.5 per cent in 1984, to only 20.9 per cent in 1991. The financial capacity of the state was also weakened as a result of its inadequate ability to tax non-state enterprises. Since many SOEs have their own collective (read private) enterprise attached to them, they have been able to exploit weaknesses in the taxation of private enterprises by manipulating transfer prices and shifting profits to them.
Government subsidies covering operating losses of SOEs and collectively owned enterprises (COEs) increased from 2 per cent of total budget in 1979 to 7.7 per cent in 1985 and 2.2 per cent in 1991. These subsidies and other types of soft-budget constraints such as loans from state-owned banks, reduced government's ability to mobilize additional revenue underpinning macro-economic reform and controlling macro-economic stability. This disequilibria pressured central Government to undertake financial and fiscal reforms in the 1990s.
The inducement measures adopted in the process of enterprise reform have brought some positive effects, including increased productivity, economic growth, an increased role for market institutions, a growing market system (no matter how distorted), and a system that is more open globally.
Politically, partial and incremental reforms softened the risk of total collapse of the economy by changing the potential earthquake into several small tremors spread in time and space. This generated support for reform, especially from the state and party bureaucracies. Meanwhile, the incongruous relationship between reform measures and the existing economic institutional structure generated stresses, conflicts, and unanticipated consequences, such as poor performance of SOEs, deteriorating macro-economic stability, and a decline in the state's credibility and capacity to manage the economy.
As a result, central Government adopted a new programme at the end of 1993 to emphasize transformation from policy adjustment to establishment of a modern enterprise system. Its priorities shifted from improving the management of individual enterprises to upgrading the state-owned economic sector as a whole. The necessary negative incentives - corporatization, regrouping and even bankruptcy - were combined with positive inducements to ensure a successful and sustainable enterprise reform. The first experiments with bankruptcy were initiated in early 1985. In 1988 the bankruptcy law became effective nationwide. In the first four years there were a total of 677 cases, some of which involved large SOEs with many employees laid off.
The main motive to corporatize existing SOEs was to deal with arbitrariness in distributional relations between the state and the enterprise and their related incentive problems. This was done by clarifying property rights and operational rights to achieve a higher degree of accountability and to form competitive and independently-managed industrial conglomerates integrating industry, business, scientific research, and finance into one entity. This entity would be able to utilize market forces to promote optimum use of existing resources and to rationalize internal organization and structure. By early 1993, more than 10,000 companies had been merged into such conglomerates.
Enterprise reform experience has shown institutional weaknesses of the old fiscal and financial regimes which led to fiscal difficulties and macro-economic imbalances and constrained both enterprise and overall reform. To ensure that positive inducements and negative incentives would become effective for enterprise reform in late 1992, the State Council adopted "The Regulation for Transforming the Operating Mechanism of the State-Owned Enterprises".
This programme called for: the creation and expansion of financial markets for bonds, stocks and other negotiable securities; markets for technology, labour, information and real estate; further reform of pricing and taxation; government reform regarding the separation of responsibility for macro-economic control and micro-economic management; and the introduction of other marked-related institutions, such as a social security system, a labour market, corporate regulation, and so on.
These macro-economic changes have also resulted in attracting foreign capital which has been the engine of China's phenomenal export success: 12 years ago exports from foreign ventures made up only 1 per cent of all China's exports. Today the figure is about 30 per cent and growing further.
The central feature of this programme was the establishment of a healthy macro-economic environment in which indirect control would be exercised through appropriate mechanisms to monitor the behaviour of increasingly autonomous economic agents. The restructuring of the financial system became essential for enterprise reform which could not succeed before the banking sector completed its commercialization.
The main goal of the financial component of this new programme was to: expand the share of central Government's fiscal income; transform state specialized banks into profit-making and risk-taking institutions; and strengthen the role of the central bank in issuing money, managing basic monetary instruments, and regulating and controlling total credits and interest rates.
The new tax reform system that became effective in 1994 aimed at unifying the tax code, simplifying the tax system and its administration, and strengthening the overall control capability of central Government by enlarging the central-local tax revenue ratio of 45:55 in 1992 to 60:40, a pattern more in line with that in other countries.
The old tax (consolidated industrial and commercial tax) was replaced by a new value-added tax at 17 per cent standard rate supplemented by a consumption tax (mainly for luxury goods) and a business tax (mainly for the service sector). A single personal income tax was also introduced. The tax rate for all enterprises was equalized at 33 per cent with some special treatment allowed - 27 and 18 per cent respectively for the first two years for high-tech companies. Along with tax reforms there were also reforms in accounting and auditing systems.
Lately government efforts have become more vigorous. First came the "contract responsibility system" (products produced over the plan could be sold on the open market). Then the "modern enterprise system" was introduced aimed at separating the state owner from day-to-day management. In general, reforms attempted to grant greater autonomy to management of SOEs, to impose financial discipline, to encourage firms to merge and restructure and to expose them to competition.
The reform also altered the traditional situation in China in the following three ways:
A true market economy cannot fully emerge until the Government does something about its ailing state enterprises employing some 100 million workers and swamped by debt, surplus labour and bloated inventories. Half of the 100,000 enterprises operate at a loss and one-third barely turn a profit. Workers earn most of their income moonlighting for private firms.
The economic importance of SOEs is waning. They now contribute just a third of the industrial output (against 75 per cent in 1981) - at a time when they are particularly costly to maintain. In 1996 the number of people laid off by SOEs increased sharply to 10 million. Ten years ago state-owned firms produced two-thirds of all manufacturing goods and accounted for four-fifths of export growth. Today, propped up with subsidies and hiding behind tariffs and other protection, SOEs still account for half of all manufacturers, but barely a fifth of the growth in exports. Losses in the state sector now exceed profits. About 70 per cent of the 100,000 state enterprises are said to lose money. This state sector imposes huge costs on the rest of the economy.
The present economic situation requires, therefore, active steps in privatizing SOEs. There are more than 300,000 SOEs, a third of them industrial. These firms still employ most urban workers (30 million more people than when the economic reforms first began). They also account for up to 90 per cent of the loans granted to enterprises by China's state banks. At the same time, they produce less than 40 per cent of its industrial output, and that share is falling.
Most of the SOEs remain technologically backward and they have an obligation to provide almost all social services to their workers. Many SOEs use only 60 per cent or less of their production capacity, and some assessments suggest that these firms could cut down about a third of their staff with no effect on output. As a result, a growing proportion of SOEs are losing money (about 50 per cent of industrial SOEs). Aggregate profits have collapsed from the equivalent of 6 per cent of GDP in the late 1980s, to about 1 per cent of GDP today.
Though it is predicted that GNP growth for 1997 will be at about 10.5 per cent, about 2 per cent of it may go into expanding stockpiles of state-produced goods that no one wants. (In 1996 these stockpiles constituted 7.8 per cent of GNP). The way out of this problem is to accelerate the restructuring of SOEs to allow a distribution of credit according to efficiency criteria.
While the central Government has tried to limit firms' access to subsidies, fresh subsidies have been supplied by China's state banks. As a result, debt among SOEs have shot up to US$120 billion at the end of 1996. Then came a panoply of new tax credits and deductions adding to implicit fiscal subsidies. The continued deficiencies in revenue collection owing to widespread tax evasion, fraud and arbitrary tax reductions and exemption did not help. Also expenditures were not effectively controlled leading to serious waste, corruption and extravagance.
Despite some progress in the development of property rights, it is still difficult to draw the line between the state as owner and company managers. The latter still have excessive control from the Government and the Party. The absence of clear definitions of ownership has also been an obstacle to foreign investment. One result of this was a process of "spontaneous privatization" which is taking place in many small state firms, a growing number of which are being stripped bare by managers and local government officials who seize assets and leave debts behind.
To reduce such spontaneous privatization, the leadership is determined to keep the 1,000 or so biggest enterprises under state control. This is sensible for the time being, but will be costly. The huge increase in bank lending ("policy loans") represents the price of delaying serious state enterprise reform. China's four main banks have bad debts equalling 22 per cent of their lending and some banks up to 80 per cent of their portfolio. In short, China's banking system is almost insolvent - its bad debts exceed its capital. Over the long-term, the costs of the financial system for the state sector will surely mount. Lending is growing faster than state output while bank profits shrink steadily as a proportion of assets.
State industry owes the state banking system a great deal of money. About US$600 billion in bank loans are outstanding in China - 90 per cent to state industry, accounting for an unusually high proportion of all financing equivalent to about 70 per cent of GDP. China has only one private bank and no meaningful capital markets, so the job of financing investment rests almost wholly with state banks. Those banks also have an unusually high proportion of bad loans (about 30 per cent of GDP) which they have small hope of ever having repaid. Bad loans in China would swallow up banks' capital several times over if banks had to account for them. By any conventional calculation the banking system is insolvent.
Since SOEs are owned by the state, they represent ideological and political commitment to social ownership of large-scale means of production. Thus, today political self-preservation is still a key obstacle to dismantling SOEs. That is why there has been a continuous debate among Chinese leaders over the issue of balancing growth, stability and reform. The problem of SOEs is identified for political convenience not as state ownership but as bad management, and the existing environment as one giving rise to unequal competition.
Political stability has always been the top priority of government policies and measures. Anything that can lead to social unrest should be carefully avoided. For example, the overemphasized full employment policy pursued over the past four decades has been the major cause of labour redundancies that are now a major stumbling block for China, hindering the development of SOEs since between a quarter and a third of employees constitute surplus labour.
Some urgent actions should be expected in the future to avoid a financial crisis:
There is a way to cut the knot in China's financial system, provided this is done soon. The government could issue government bonds to the value of the banks' bad debts, allowing the banks to write off their bad loans and recapitalise themselves on the understanding that henceforth the state would not pick up further losses. The SOEs would then have to face competition without subsidies. For many that would mean bankruptcy, but for others it might prove viable.
Financially and organizationally China is able to do it judging from the documents of the last Communist Party Congress (September 1997). A compromise between preserving some control over the SOEs and continuing China's economic miracle has been achieved, i.e speeding up the privatization of small firms and modernizing the management structure of bigger ones, while keeping them under state ownership and control for the time being. But for how long?
It is expected that next year the state-run banks will be given more freedom to refuse to lend money. More state-run firms will also be allowed to raise capital by issuing bonds.
The new stage of reform will be to ensure that larger state firms become more profitable, while smaller firms are allowed to merge, go bankrupt or be sold. Over the next 25 years, the World Bank expects the Chinese economy to undergo a transformation which took about 65 years in Latin America and 80 years in the world's most advanced economies. China's particular strengths are its high rates of savings, its pragmatic reforms, a disciplined and relatively well-educated workforce, and rich overseas Chinese eager to invest in the country of their ethnic and cultural origin.
The challenge for policy makers is to find a sustainable balance between long-term economic needs for SOE reform and the short-term political need for subsidies. Immediate government priorities are to standardize bankruptcy practice, encourage mergers, and promote employment of people released from SOEs. The Government long-term objective is to concentrate state resources on building-up a core group of one thousand companies that can dominate China's major economic sectors and compete on a global scale. Meanwhile, 240,000 smaller SOEs will be released to the private sector. Further expansion of the rural non farming sector and the private sector will requires further liberalization of capital and labour markets.
Even though the economic cost of "gradualism" is high, at least its social costs are much lower than the alternative "shock therapy". At the same time, delaying the reform of loss-making SOEs for too long will only protract inefficiency at the micro-economic level, and eventually will result in inefficient resource allocation at the macro level. In the near term, China will probably concentrate on redoubling central control over its biggest state enterprises, especially in "pillar" industries such as arms, energy and steel, to avoid the social strain of throwing large numbers of workers onto the street.
The above fiscal and financial reforms can only be addressed in tandem with a strong and assertive state. Successful devolution of authority from central Government to local Governments and from the Government to enterprises and households requires a strong state that can ensure that the reform moves in the desired direction reducing uncertainty and instability. In a country where political reform has lagged behind economic reform, the emphasis on an active role for the state may have some drawbacks for economic reform.
The prime ambition of the new leaders is simple: stability. They are supported by the people who profoundly fear disorder. While the Chinese now want to concentrate on private concerns, they want to do so in a context of political stability and public order. That allows the regime to maintain a degree of authoritarianism and maintain Deng's dual system of economic progress and political rigidity as long as people's social expectations are being met.
A striking lesson of transition in many countries is the importance of the new businesses that emerge in response to the lifting of restrictions and liberalization. To be widespread and effective, entry must be cheap and administratively easy and new firms must have broad access to markets for their products and inputs. China started its reform with liberalization for new entrants to the market and the majority of new entrants were at first community-owned township and village enterprises. Most recently, new private firms and joint-ventures have constituted the most dynamic sources of growth, employment and exports. In Russia, the main emphasis was first on state property privatization, delaying opening of the market to new entrants. The first attempt in this direction was made by Gorbachev when he tried unsuccessfully to spur the development of cooperatives and new small firms. Even today in Russia the most attention is given to the privatization of SOEs and much less to the development of new firms.
As a result, China alone, among all the economies in transition, has had sufficient resources in output and productivity growth - and has not needed to address privatization in an urgent way. Only now, after almost 20 years of reforms, is China getting to the task of privatizing SOEs. It deliberately chose to start with the simplest tasks and leave the most difficult ones until later. At the beginning of the reforms the Chinese were wise enough to realize that they did not understand all the possible consequences, and they thus set out in an experimental way, trying out different kinds of small changes and seeing what worked best.
Though the Chinese did not have a detailed plan, it does not mean that "gradualism" was not a strategy. Gradualism was implicit in Chinese culture and the reform approach from the beginning, and became explicit at the start of the urban reforms in 1984. Because of disagreements among the leadership about how far the reforms should go, official policy was developed in the gradual and tentative manner necessary to maintain a consensus. Given the problem of political backlashes seen in some Eastern European countries (the rise of extreme left and right), this too must be seen as another plus for the Chinese reformers. They avoided major political and social destabilization. An example of how the gradualist experiment has worked successfully in China is the household responsibility reform started in a limited number of regions. When household farming clearly became the most successful system economically, it was adopted as a national model.
Another key factor was that the overall direction of policy remained firm. New problems were addressed by further reforms and not by major retreats. What the Chinese discovered by employing these inductive methods was learning by doing. It was a reform dynamic in which partial reform measures created both significant success as well as a need for further reforms. China's lessons stand as evidence that it is not necessary to have all major sectors of the economy operating under free markets at the same time in order to obtain rapid increases in efficiency and living standards.
Another advantage of the Chinese approach is that it created a self-sustaining process in which small reforms aimed at relatively easy problems led to economic expansion, which in turn led to increased political support for further reforms. It also limited the amount of change that the Chinese people had to deal with at any one time. Change, especially increased uncertainty, is extremely stressful - as the people of Russia have already discovered. The Chinese idea has been to let people come to the market rather than to force it on them. Reforms in China have been drastic, gradual, broad and pervasive. They have ranged from agriculture to manufacturing, services and trade, and from price to fiscal and financial matters.
In summary, reforms have been deepening and widening not because there has been a grand plan to pursue a complete transformation from a planned economy to a market economy, but rather because reforms have been pushed forward when the economic, political and social climates have permitted and were propitious, and when altered expectations and the urgency of readdressing newly emerging problems have required action. Consequently, reform in China has typically followed a path of uneven development in which balance is restored as a result of pressures, incentives and compulsions, and where in emerging disequilibrium there calls for new development which in turn leads to similar disequilibrium. Vast social transformation thus involves a complicated process of institutional change which is not only incremental and gradual but also includes a series of subsequent changes.
At the same time it would be a mistake to state that Russian reformers were completely wrong and that they should have followed the Chinese way. Many countries were just not in a position to choose between gradual and rapid strategies. In Russia the economic reform parallelled the dismantling of a repressive political system. It had to overcome huge trade declines as well as severe macroeconomic imbalances and structural distortions created by central planning. As yet it has not been able to generate the savings necessary to sustain its greatly overbuilt state sector.
Russia faced an extremely difficult choice: rapid systematic reform entailing deep and often painful structural adjustment, or incremental efforts to introduce change while trying to protect the status quo. The latter worked in China, but in Russia it would lead to spiralling inflation and economic and political disarray. Rapid reform has been easier when political change has been rapid and fundamental. Citizens who supported the new political system also supported market-oriented policies. In Russia, quite a large part of the population did not support either the political or the economic changes.
China had favourable initial conditions for gradual reform. Its policy-makers did not have to confront the same immediate obstacles that Russia faced. China had to devise and implement a set of market-oriented reforms that provided growth-promoting incentives to farmers and workers while maintaining macroeconomic control.
Unlike Russia, China embarked on its transition with a very large oppressed rural economy and a relatively-speaking smaller state sector. The effects of initial rural reform were very positive. Partial liberalization and the development of a non-state-sector created almost 100 million new jobs between 1978 and 1994 and sparked rapid productivity gains without imposing sharp adjustments on state industries. As a result, rising incomes from the first wave of reforms were able to build momentum for further, more difficult changes in a self-reinforcing process. Adjustment in Russia, by contrast, has involved painful downsizing of an overbuilt state sector previously sustained by large cross-subsidies, especially from the energy sector.
Another reason for China's strong performance is that growth and effective macroeconomic management encouraged a high rate of savings from initially low levels of monetization. Russia's economy, on the other hand, was already highly monetized in 1990 with a large "money overhang" representing resources that had already been supplied to the planned economy. This overhang caused high inflation when prices were freed, eroding confidence in financial savings.
Therefore, starting conditions for economic reforms in Russia and in China were very different. No transition economy can escape its starting conditions, but reformers can and do make choices that critically affect the early success and longer-term stability of market reforms.
Despite the fact that Russian conditions differed significantly from China's, the Chinese experience should still be studied for possible application. The major lesson that policy-makers could learn is the benefit of starting small and focusing on reforming those aspects of the economy that offer the greatest probability of success. These successes can be built by gradually moving on to more difficult problems, thereby maximizing the chance that the vast majority of people will see the reforms as a positive factor in their own lives. Where transition has accompanied rapid and broadly-based growth, as in China, poverty has fallen even though income disparities may have increased. In Russia, declining output and rising inequality caused poverty to rise. What is essential is long-term economic growth, and privatization is just one of many possible tools.
In this controversy, the authors of this study are not inclined to champion either extreme position. We do not feel it makes sense to assess the state of affairs in Russia's economy as arising merely from self-serving political interests or ideological prejudices. We believe there exists an inexorable over-and-above-party logic predetermined by the actual state of affairs which can be abolished by anyone. This research is neither a fresh round of perestroika nor an indictment of present-day reformers. The paper is an effort to sort out the goings-on impartially. Hence, before an assessment of the results of privatization, we think it is worthwhile to consider the root causes of privatization itself and of the whole array of economic reforms.
In assessing the present state of affairs, one should note that the main structural problems and the dismal state of Russia's economy are rooted in the militarized planned system built up for the war that has outlived its day by something like a half-century. The continued orientation towards export of non-renewable resources, living off fixed capital, economizing on innovations, and neglect of the environment over a period of several decades created a semblance of production growth and kept people's well-being at a minimum level. But this approach ultimately plunged the system into bankruptcy, for it was a system in which the economy was directed not by common sense but by bureaucrats (often in a state of ignorance) who arrogated the right of planning and distribution proceeding from subjective, politicized, and often purely careerist motives. The list of "sad records" set by the Soviet-planned economy is a long one. Here is just one typical example epitomizing the absurdity of the old system.
The Soviet Union led the world in the turnout of low-grade machines. While lagging behind the United States by close to one-third in the production of grain, we were 6.4 times ahead of the United States in the manufacture of tractors, and 16 times (sic!) ahead in the manufacture of grain harvesters. It would have taken US industry some 70 years of hard work to turn out as many grain harvesters as we had lined up for repair in 1987 (4,10).
As a result of that kind of economic management, the country faced by the end of the 1970s a national income growth of zero per cent. Collapse was in the offing and the leaders of the state tried to avert it through useless ways and means, and what is more, without changing the economic mechanism.
The first step to economic disaster after 1985 was the "acceleration" idea, which made the investment burden even heavier and further intensified structural disproportions. At the time, the fall in world energy prices turned Russia's foreign-trade balance negative and shrank the import of consumer goods and foodstuffs, initiating disintegration of the market. The chaotic anti-alcohol campaign aimed at cutting down production and not demand, dealt another heavy blow to the economy.
The second economic disaster struck the USSR at the end of 1988 when inflation was still latent. This was evident in the disappearance of goods from shop shelves and the irretrievable devaluation of people's savings and the state budget deficit exceeded all the admissible norms (more than 20 per cent of GDP). At the time there was still a chance to halt disaster, but the Government's failure to understand the significance of macroeconomic equilibrium threw finances into a crisis which began to break up the administrative system.
In an effort to slow investments, government put a freeze on earlier construction projects totalling R24 billion, but at the same time started up new ones - valued at R59 billion. The debt arrears of enterprises on loans and inter-firm credits went up by R17.5 billion. External indebtedness doubled, as compared with 1985, and some US$3 billion was paid out in interest charges alone. A spasmodic drive for cash incomes got under way and the anti-alcohol campaign capitulated: instead of the planned reduction by R11.5 billion, earnings from the sale of alcoholic products went up by R3 billion.
In fact, it was the collapse of the financial system and not the ill will of "democrats who sold themselves to America" that made the system "ungovernable". The disintegration of finances resulted in shrinking production and the resulting higher tax on wages sparked off a strike movement and led to the breakup of trade unions as a "school of communism"; confidence in the rouble evaporated and shop shelves were left bare - hence the emergence of a cornucopia of reformist programmes.
Regrettably however, these programmes, including the memorable "500 Days" programme, became the object of fierce political infighting. Mutual destruction became the main aim of the legislative and executive arms of power, and at this point the economy was put on the back burner because unity of political will had disappeared. The Union Republics fled from the sinking ship dealing yet another blow to Russia's national economy. The Council for Mutual Economic Assistance disintegrated and the social basis of reform was destroyed due to lack of nationwide support. Finally, by the beginning of 1992, fear of famine spread across the country. Now people easily forget the gravity of that crisis, but this forgetfulness provides evidence of some indisputable achievements of the present-day reformers.
By the start of the 1990s an economic disaster could no longer be averted and it was clear that something had to be done. It is one thing to carry out reforms under political stability and a budget surplus, and it is quite another to try to restructure an economy during a political earthquake with the disintegration of production-and-trade ties, the destruction of the national-economic system (which had up to then operated on the single factory principle), and a rapid growth of foreign debt and "demise" of fixed assets with material and foreign-currency reserves at zero. Therein lies the key to understanding Russia's present-day economic problems, including those of privatization.
What then are the results of the past five years since the start of the "Gaidar" reform? These cannot be assessed simply. First of all, there is a need to reject accusations that "market liberals" plundered the country. It is clear that Russia had been stripped of its wealth and plunged into economic disaster due to lack of a market. The reforms launched in 1992 produced some positive results and there were prospects of a healthier economy. The people developed a taste for business and ownership, the rouble gained strength and became convertible, and the shortage of goods on the market lessened.
According to Anders Aslund (1,17-18), there are five distinct features proving that a market economy has already been set up in Russia:
1. The economy has been depoliticized with the end of domination by ideology and politics.
2. Centralized state allocation, with central orders to enterprises on physical output targets and deliveries, has ended. While horizontal trade between independent enterprises has begun. Most of the export and import quotas have gone and protectionism amounts to customs tariffs. Allocation has been depoliticized.
3. State ownership has been reduced to less than half, and the remaining state enterprises are independent as in a market economy. Ownership has been depoliticized.
4. The economy has been monetized and the rouble has become a real, reasonably convertible currency with a unified exchange rate that is market-determined and floating;
5. Hard budget constraints have been introduced for enterprises. The budget deficit has been reduced to 10 per cent of GDP. A financial market has emerged and credit constraints have lowered the rate of inflation. The credit and financial systems have also been depoliticized.
Evidence that a real market economy exists in Russia also comes from the market-oriented restructuring which is under way. The proportion of produced GDP is becoming less distorted. The share of consumption in the national income has been growing, though inadequately. More small enterprises are starting up and the structure of foreign trade is being normalized. Enterprises have finally begun to show concern about cost-cutting. The production of goods and services for which there is no demand is coming to an end. Prices are being adapted to the conditions of the market.
At the same time, economic reforms in Russia have turned out highly contradictory and their positive impact has been limited. First of all, they caused a sharp social stratification causing growing tension and disappointment as election results have shown. Even Patriarch Alexis II, head of the Russian Orthodox Church, remarked in his 1997 New Year's message that "the differentiation of incomes in Russia poses a threat to the equality of people's civil rights". Indeed, the ratio of incomes of the richest 10 per cent to the poorest 10 per cent now stands in Russia at 15 to one (or even 20 to one according to other sources) is yet another "sad record" (6,11).
In short, privatization in Russia has not attained its main goal yet; namely, the creation of a class of "healthy owners". The struggle against monopolism has ended in failure. Far from being reduced, the bureaucratic power of the state has in fact increased while in some ways becoming subtler but no less inclined to authoritarianism and corruption than it used to be. The spheres which ensure the country's tomorrow - education, culture, science and public health care - have been sidelined. All this poses a threat to the general prospect of transition to a developed market economy. There are grounds for anxiety because Russia's economy has yet to retreat from the red line beyond which irreversible degradation of the country's industry and labour potential sets in; according to some it has already gone beyond that line. Estimates (6,11) indicate that the decline of GDP with respect to the basis level in Russia is 50 per cent, while the level of food dependence (the share of imports in consumption of foodstuffs) is also 50 per cent, and the appropriations for science is 0.32 per cent. The effects of this are painful, together with the reality of systemic deformation.
But one should not take a totally negative view of events, even of the drop in production, because in some cases it is not a misfortune but rather a reasonable way out. Artificially-supported ineffective lines of production in whatever industrial sector, are, in fact, additional motors giving inflation a push. Even in raw material industries, the main problem today is not growth of extracted resources, but their effective use. On the whole, the state of the economy has to be declared unsatisfactory. What is the main reason?
We believe that the main reason for most of the reverses of current reforms lies at the very heart of these same reforms, namely in the conception of liberal monetarism. There is no doubt that monetarist measures are necessary and important to prepare the conditions of transition to a market economy, but nowhere in the world and at no time in history were they able to generate an economically harmonious market system alone. They fail to create incentives for constructive economic activity, particularly in the situation Russia finds itself in today where:
In developed countries the share of the state in national income fluctuates between 13-25 per cent, and any partial change in ownership does not cause any fundamental socioeconomic change on a national scale. But things are different in Russia where state ownership, up to recently, was virtually the sole form of ownership (more than 90 per cent). This is why in contrast to other countries, what is happening in Russia is not just partial transfer of property from one set of owners to another, but rather a radical transformation of all forms and relations of ownership.
At the start of privatization in Russia, the first thing was to determine the limits of admissible de-nationlization and identify the productive factors that were truly public assets. We have in mind lines of production which by virtue of their vast scientific capital and labour resource-intensiveness may, in principle, not be initially feasible for privatization. In determining this boundary, it was necessary to take into account Russia's specific features including its natural and climatic conditions, vast distances, historical traditions and questions of military security. The establishment of a boundary for admissible de-nationalization should not, of course, have meant maintaining old methods of management within the area of direct state interests. There was a need for a parallel effort to solve two problems:
Regrettably, the concept of privatization was based on the notion of complete inadmissibility of the state's direct participation in economic activity. This was borrowed from the free-trade theoretical arsenal of the 19th century in contradiction to world experience of the second half of the 20th century. The result was that a large-scale reassignment of property was started from the ruins of the state economy. There is also every indication that no amount of sacrifice, abuse or social problems could shake the conviction of the advocates of the doctrine that a mere switch in control of resources and their use by private persons constitute the essence of the ownership problem and a crucial determinant of renewal of economic incentives and renaissance of entrepreneurial activity.
The main mistake was that privatization was started as merely a formal and legal process of replacement of the state owner but was not preceded by the shaping of new effective owners to whom it could be reliably turned over. Experience has shown that without an effective owner operating in a favourable investment climate, paying taxes fully and regularly, and providing the society with quality jobs (3,9), privatization is not only pointless, but can be harmful.
Three main factors are required for the successful functioning of privatized enterprises:
The absence of these three factors in Russia today renders the existence of state, private and mixed enterprises ineffective. Three other mistakes were made in the practical effort of privatization:
The present state of Russia's finance and credit, and gaps in the monetary system produced a massive phenomenon of illiquidity, and one could say that an "objective" prerequisite was created for declaration of bankruptcy and cheap sale and asset appropriation for virtually any enterprise in Russia.
Those were the conditions for "shock" privatization in Russia. The above-mentioned problems are described in greater detail below. To conclude this section, we offer a quote reflecting another specific feature of privatization in Russia: "Shock methods should not be applied to enterprises, whether state-owned or those recently equitized. These methods are applicable to organisms with an ability to react, to provide feedback connections, and are capable of responding to external influences. Our enterprises are, in effect, not organisms, but mechanisms which cannot improve themselves: they cannot be taught - they can only be broken up" (3,37). The results of this breakup are well-known. The absolute volume of production in Russia continues to fall and unfavourable structural shifts are taking place in the economy. Thus, whereas in the USSR, the proportion of raw-material and power industries came to about 8 per cent of the total of GNP, today it is over one-third. With the overall decline in the level of production by 51 per cent in 1990-1995, the volume of output in light industry has dropped to one-sixth (sic!), and in the food industry and engineering - down to about 40 per cent." (11,7)
The process of "allocation" of state property got under way in Russia (then part of the USSR) long before the adoption of official decisions on privatization. It started the adoption in 1988 of the State Enterprise (Association) Act whose task was to give economic independence to state enterprises and destroy the managerial pyramid of "Gosplan (State Planning Committee) - ministries - enterprises". In 1988-1989, new entities appeared in Russia's economy. Work collectives began to take out leases on state enterprises (with or without buyout), and a great number of cooperatives, joint-stock companies and partnerships were also set up. The commercialization of the state sector proceeded to such an extent that it even affected the Ministry of Defense, including army units. All this took place in the absence of a requisite system of special accounting and control, which is why the real magnitude of the first stage of privatization is still unknown. We use approximate quantitative assessments (according to the OECD estimate, some 2,000 enterprises underwent spontaneous privatization) or take on trust assertions like the following: "the vesting of officials with the right to commercial activity allowed them to pillage a vast and very rich country in a short time without breaking any laws in the process. Indeed, if an official (the director of a state enterprise or the head of a department) sells highly valuable raw materials at throw away prices, or buys absolutely useless goods at exorbitant prices, there is, technically speaking, no breach of law (it is virtually impossible to prove that a bribe has been given or taken)" (3,10).
Prior to the enactment of new legislation on privatization, Russia's Parliament authorized the State Committee for Management of State Property (hereinafter "SCP") to check the results of the "spontaneous" privatization - lease contracts with the right of buyout concluded without an auction; the legality of transfer of state enterprise property to the balance sheet of cooperatives, joint-stock companies and partnerships; and any other wrongful acts in privatization deals. However, the SCP has failed to carry out this work.
The preliminary stage (1990-1991)
The drafting of legislation on privatization began at this stage to provide a normative base regulating possession, use and disposal of ownership, and also its transformation from one form to another. Its cornerstone is RF Act No. 1531-1 of July 3, 1991, on the Privatization of State and Municipal Enterprises in the RF (hereinafter the "Privatization Act"), adopted in the pursuance of the USSR Act of July 1, 1991, on the Principles of De-Etatization and Privatization of Enterprises. By mid-1992, the RF Parliament adopted a number of laws and decrees regulating the processes of privatization and bankruptcy of economic-management units, including the RF Act of July 3, 1991 on Inscribed Privatization Accounts and Deposits in the RSFSR. At the same time, the basis was laid for an institutional mechanism for privatization which also continued to develop in the subsequent period.The Privatization Act vested the SCP and its territorial divisions with the task of pursuing a single state policy of privatization. The SCP was set up by a Decree of the RF Council of Ministers (No. 35 of January 21, 1991) as a Federal agency of the executive branch. It is now authorized to deal with the planning and implementation of the normative base for privatization; the assignment of work in the valuation of units aimed for privatization; the analysis of the privatization process and its results; the disposal and management of state property; and arrangements for control and effective use and safety of property held in Federal ownership. The SCP is financed from the RF budget and out of deductions from privatization revenues.
The Privatization Act also served as the basis for the creation of the Russia Federal Property Fund (hereinafter "FPF") operating under the RF Government as a specialized financial institution to sell facilities held in Federal ownership. Until time of sale it exercises ownership and after receives and remits dividends and earnings from privatization to the RF budget. The FPF is a "legal person" and is in possession of separate property belonging to it by right of operational management. It is financed from the revenues received from privatization.
Yet another state institution was set up in September 1993 as part of the institutional mechanism of privatization: the Federal Board for the Affairs of Insolvency (Bankruptcy) (hereinafter "FBB"). Among its main functions are to pursue a state policy designed to avert bankruptcy of enterprises and to keep a record of enterprises unable to pay; to represent the interests of the state in settling matters connected with the initiation of judicial proceedings in cases of bankruptcy and adoption of decisions on the bailout of state enterprises; to render assistance to enterprises showing signs of bankruptcy; to nominate candidates for receivership and bankruptcy trustees; and to organize operations in attracting RF and foreign investments for restructuring to organize work in setting up norms and methods of bankruptcy procedures based on the Bankruptcy Act. The FBB is financed from the Federal budget and from the sale of debtor enterprises and enterprise property undergoing liquidation.
At this stage, the executive branch has actively involved foreign organizations and specialists in preparing the normative framework for privatization. Fifteen foreign advisers have been working on it in the central apparatus of the SCP alone. These efforts involved the European Communities Commission, the European Bank for Reconstruction and Development and a host of Western consulting firms. Notably, the European Bank for Reconstruction and Development prepared a 600-page "Privatization Guide" issued by the Central European Publishers. However, in the opinion of specialists - and as later confirmed by developments - positive world experience in privatization, notably that of Western Europe in the post-privatization phase, was not duly taken into account in the developing of this normative base.
Despite the adoption of relevant legislation during this period, practical privatization in Russia did not fully go forward, and special measures had to be taken by the President and Government to step up the process.
As a result, the State Programme of Privatization of State and Municipal Enterprises for 1992 (hereinafter the "State Privatization Programme") was adopted by Parliament only in June. 1992 was expected to be a year of massive privatization, covering some 60 per cent of enterprises in light industry, road transport and auto-repair enterprises, retail trade, everyday services for the population and 50 per cent of enterprises in the building and structural-materials industry, the food industry, public catering, and other industries determining the state of the market infrastructure. Instead, according to the SCP, only 46,800 enterprises (18.6 per cent of the total) were privatized in 1991-1992.
In August 1992, the President issued Edict No. 914 on the Introduction of a System of Privatization Vouchers in the RF, ushering in so-called voucher privatization, which, according to the intention of its architects, was to have paved the way for access by everyone to state property. The State Privatization Programme announced the following goals:
The last of these points became the main objective of the next stage.
As the process of privatization proceeded, it became clear that none of the tasks set by the State Privatization Programme, except the fifth one, were being fulfilled. That substantially altered the mind set of the population and supporters of reforms in those two years reduced by one-third and the number of opponents rose to over 60 per cent (9,9). There was a sharpening of disagreement on this score between and within the executive bodies and the legislature.
The main point at issue was the assessment of the value of assets owned by the state which was carried out during the early stages of privatization by enterprises themselves on the basis of their balance-sheet reports. The management of enterprises had a stake in understating these data, and there were even cases of enterprises being acquired for next to nothing with a subsequent fold-up of economic activity and resale of blocks of shares. This happened, for instance, with the ZIL motor works, the largest engineering enterprise in Moscow.
The Independent Strategy Bulletin (September 12, 1994) remarked that the bulk of Russia's fixed production assets was sold in the course of privatization for something like US$5 billion. Even assuming that the value of fixed production assets in Russia equals its GDP (in the leading Western countries these exceed GDP by 2.4-2.8 times), i.e. US$300-400 billion, revenues from privatization were insignificant. Thus, if the market value of the Gazprom concern (which owns 30 per cent of the world's proven reserves of natural gas) is divided by the volume of its explored reserves, one will find that the per-unit value is equal to 0.3 US cents per barrel of oil equivalent (as of autumn 1994). The same indicator for British Gas is about US$10.30 per barrel. Here is another example: the Rostelekom company which owns 80 per cent of telephone lines in Russia, has a per-unit value of about US$50 per access line; by contrast, the Japanese NTT company has a value of US$2,430 (11,19).
Some US$3 billion was allocated to the Programme of Support for Privatization and Structural Transformations in Russia (1993-1994), with about US$2.3 billion in the form of credits from the World Bank, the European Bank for Reconstruction and Development, and export-and-import banks, made available at 7 per cent per annum. Reports on the use of these monies have never been published.
Another essential characteristic of this stage of privatization is that the process now and again acquires a criminal hue, as is exemplified by the Novosibirsk Tin Works which produces the world's highest-quality tin and is the biggest in the country and in Europe. Its former state director fraudulently violated the law by understating the value of shares many times over and including in the list of shareholders representatives of local authorities, officials of the Ministry of Metallurgy, and members of the militia and procurator's office. He also founded a semi-fictitious Russo-British firm Armet, putting into it 3,500 of his own (sic!) vouchers and R121 million illegally extracted from the profits of the plant and transferring to this firm (i.e. to himself) 14 per cent of the shares (apart from the block of shares he already had in his possession). In addition to this, he concealed from taxation US$1.2 million of personal earnings which he deposited into his own Western bank account.
Since then, the pace of privatization has markedly slowed down and has become lax. This is due to the fact that the State Privatization Programme has been, for all practical purposes, fulfilled. Only a few odd units remain to be privatized and also a period of "sobering up" has set in as the mistakes made during the privatization "race" have become quite clear and time has come to put things in order. There is now the need to improve accounting and recording; to analyse the state of the normative framework and to adjust it; to exercise control of the effect of restrictions imposed by legislation on the privatization of state-owned property; to put in order the system of post-privatization supervision and support for enterprises; to set right matters in investment auctions (whose share of sales came to only 2.3 per cent); and to analyse breaches caused by unlawful acts of central and, especially, local privatization agencies.
It is understandable that the Russian Parliament is insisting on a review of decisions on privatization of some of the major enterprises, notably because of incorrect assessments of the value of assets, precedents of criminal privatization, fraudulent auctions, and illegal deals with foreign persons and their intermediaries who have even acquired shares of defence enterprises, and so on.
Most breaches of legislation on privatization and abuses in this area were allowed to occur at the stage of creation, reorganization or liquidation of enterprises. There are numerous breaches of law regulating lease relations (especially of the right to property buyout) and leasehold and contracting relations. Cases have been noted of registration of founding documents contrary to legal standards in effect; of "lobbying" through SCP officials and its local agencies for decisions infringing the property interests of the state or of competitors; of entry by managers of state-owned enterprises into the authorized capital of commercial structures and of their own "intellectual property" evaluated at extremely high rates; and of use by persons in office of imperfections in legislation for their own interests (on lease, incorporation, intellectual property and know-how, etc.) (11,22).
The fact that enterprises can now be purchased for money is a distinctive and key feature of the present stage of privatization. But this does not increase the intensiveness of privatization because the capital acquired by Russia's "nouveaux riche" during the period of "primitive accumulation" is still being sent abroad, while foreign business is still not rushing into the country because of lack of a favourable investment climate. As for the people of Russia, they simply have no money. The monetary backup of Russia's GDP dropped from 76 per cent in 1991 to 8.5 per cent in 1995, representing a circulation of the rouble down to one-tenth or even one-twelfth of the previous norm.
Investment activity connected with privatization can be illustrated by Federal Property Fund (FPF) efforts to attract into production Russian and foreign capital through the sale of enterprises and blocks of shares held in Federal ownership. The FPF and its territorial agencies arrange investment and commercial contests (tenders) for the largest enterprises. In 1993-1995 they held 125 such contests, including 121 investment contests. Investments came to R1.426 billion and US$1.499 million. Foreign firms and joint-ventures with foreign capital won 21 contests (17 per cent of the total). Their investments added up, respectively, to 18 per cent and 6 per cent of the total amount in roubles and dollars. In 1994, 23 out of 30 contests were held with one participant. However, this practice was prohibited in 1995 with the enactment of the Russian Civil Code (Article 447, Clause 5).
An analysis of fulfilment of FPF-concluded purchase and sale contracts and of investment programmes, brought to light a great many breaches of contractual obligations. Among them, late submission of documents at admission of investments, delay in the admission of investments and admission of investments short of the full amount, etc. These breaches affected more than half of the contracts, including contracts involving such large enterprises as Bratsk Aluminium Works, AvtoVAZ, Volzhsky Pipe Works, Stavropolpolymer. Altogether, according to FPF data, the actual fulfilment of investment obligations on completed stages of programmes involving 125 contracts came to 53 per cent in rouble investments and 47 per cent in dollar investments by the beginning of 1996.(11,26)
An analysis of contest participants shows that most of them belonged to a limited number of banking groups engaged in a struggle using less-than-proper methods. There have been cases of unwarranted debarring from contests of participants with registered bids.
The organization and practical method used in attracting investments in Russia's economy is, on the whole, primitive. Investors and issuers are not expected to work through investment programmes seriously in conformity with generally accepted requirements, or invite independent experts, nor to coordinate investment programmes with the issuers.
In June 1995, the FPF organized the sale of state-owned blocks of shares of privatized enterprises. The shares of the major joint-stock companies were sold at all-Russia and interregional specialized auctions. However, the planned revenues were not realised. In order to compensate for this, the SCP initiated additional sales of the most highly-profitable enterprises in the fuel-and-power and chemical complexes, marine and air transport, the gas industry, communications and the forest industry. A special timetable was established for this purpose to sell the shares of 136 enterprises most attractive to investors. Out of the 57 blocks of shares up for sale, 16 blocks were not sold and no information was issued on the remainder. Experts believe that such an approach to privatization and sales is absurd from the standpoint of economic common sense. (11,28)
In 1995, the FPF held 8,890 sales. The sum-total price of shares offered had a nominal value of R155 billion. Shares with a nominal value of R67.6 billion (43.6 per cent) were in fact sold. Total revenue came to R1.127 billion. Altogether, by the beginning of 1996, proceeds from the sale of assets held in state and municipal ownership came to R3.596 billion. R1.105 of this billion was remitted to the Federal budget (11,28).
Despite the fast pace of privatization, revenues from it did not become a stable or significant revenue source for the state budget. The fiscal goal of privatization has not been attained. In 1993-1996, earnings from privatization came to only 0.02-0.04 per cent of GDP and to 0.13-0.16 per cent of Federal budget revenues. According to the Central Department of the Federal Treasury privatization yielded for the Federal budget R39.6 billion in 1992, R66.365 billion in 1993, R116.282 billion in 1994, and R286.22 billion in 1995 (omitting revenues from collateralized auctions). The Government's expectations that privatization would help reduce the budget deficit, promote the process of financial stabilization, and provide funds for social protection and development of social infrastructure facilities, were not fulfilled. Budget targets for non-tax revenues were met not through effective privatization, but through the sellout of state-owned reserves. This yielded over 95 per cent of this type of revenue without taking into account the results of collateralized auctions.
The fulfilment of budget targets in revenues from privatization in 1995 came to 38.84 per cent under the Federal Act of March 23, 1995, and to 71.21 per cent under the Federal Act of December 27, 1995, which had almost halved initial targets (11,41). These figures take into account revenues from collateralized auctions but which should not be counted as a matter of principle because the pledging of shares does not amount to their sale or to privatization of enterprises. The collateralized auctions tend to increase the internal debt and the aforesaid amounts must be put into the same basket with debts. Once the preceding figures have been cleared, we will find that the initial budget target for revenues from privatization was fulfilled only by 3.26 per cent. This is an indication of the competence of the Federal privatization agencies in attaining publicly declared goals having budgetary impact on the economy.
Privatization is being carried out on the basis of the Privatization Act, the President's edicts, the Government's decrees, and departmental normative enactments. Some aspects of privatization are also being regulated by the Civil Code (enacted on November 30, 1994) and the Joint-Stock Company Act (November 24, 1995). Following the conflict between the President and the Parliament in October 1993, the drafting and adoption of normative enactments on privatization was conducted entirely by the executive branch.
The new body of Parliament (State Duma) which was elected in December 1995, at once devoted attention to matters of privatization, adopting in February 1996 two special decrees on auditing the course and results of privatization. Consequently, the differences between the two branches of government on this matter continue.
An analysis of the state of the legal framework for privatization carried out by specialists (11,10-14) has shown that on the whole it "fails to meet the goals of the State Privatization Programme, is internally contradictory, has mutually exclusive provisions, and is in breach of the principles of the supremacy of the law". The norms of the law are being replaced by the President's edicts with instructions and statutes of departmental agencies of executive power, which, for the most part, are not executed (11,11). Many enactments on norms and methods issued by the SCP, the FPF and the FBB not only engage in arbitrary interpretation by the higher authorities, but are not even subjected to legal expert examination and registration with the Ministry of Justice. This has already led to the declaration by the General Procurator's Office of the illegality of some transactions, notably, at collateralized auctions.
From the lengthy list compiled by experts on the shortcomings of this normative base now in effect, let us identify those which affect the interests of RF industry. First, the process of privatization does not take into account intellectual property, modern technologies or the science-intensive nature of production. No normative mechanisms for the management of state property in all its forms have been elaborated. The role of state property in ensuring the country's independence, security and defence are yet to be defined. There is no list of the special interests of the state where privatization could be inadmissible for the time being, including defence enterprises. Nothing has been done to establish measures to prevent the loss of state control of strategically important enterprises. In 1992-1995, 1,110 enterprises of the military-industrial complex were incorporated, and of these 20 per cent have already been declared bankrupt. In 1992-1994, of the 1,666 enterprises in engineering, 1,389 (83.4 per cent) were incorporated, leading to a decline in production (by 11.5 per cent in 1992, by 14.9 per cent in 1993, and by 43.9 per cent in 1994).
No effective measures have been taken to protect, at least temporarily, national sovereignty and the rights of Russian entrepreneurs. The only effective restriction has been imposed on privatization to foreign enterprises in the fuel-and-power sector and in the processing of precious metals and radioactive and rare-earth elements. At the same time, no provision has been made to control monopoly buy-up by foreign capital in the secondary market of shares of enterprises strategically and economically important to Russia. Thus, Russia's aluminium industry is now almost entirely in the hands of foreign capital. For example, the US corporation that has acquired through dummy firms blocks of shares (from 7 per cent to 34 per cent) in 19 aircraft enterprises, several of which are very well known. Finally, the creation of equal conditions for foreign and Russian investors for participation in privatization, despite their unequal financial strength and level of development, tends to infringe on the rights of Russian citizens and channels national wealth abroad. This is also due to the gap in the rouble's purchasing-power against the US dollar and the foreign-exchange rate of the rouble which halved between 1993 and 1995.
There have also been problems with regulating relations between the centre and the regions in the management and disposal of state-owned property, distribution of rights and responsibilities, or appointment of state representatives to joint-stock companies. The norms restricting monopolism are designed for the domestic market and are not suitable for an open economy because they fail to promote the competitiveness of Russian enterprises on the world market.
Measures for post-privatization control and audit have not been worked out and responsible organizations and sources of required funds have not been designated. No provision has been made for measures to prevent the suppression of commodity producers, and no sanctions are applied for nonfulfillment of post-privatization obligations. The absence of restrictions and measures for state regulation of the buy-up of controlling blocks of shares leads to a violation of the technological unity of major producer associations and hurts the country's macroeconomic interests.
The normative base for privatization requires development and correction. In particular, there is a need to improve the norms connected with procedures for forced bankruptcy and the voluntary liquidation of enterprises through investment contests, etc. Some shortcomings could be eliminated immediately, for instance, a single legal base could be created for leasing. Two different methods confirmed by the SCP and a variety of different procedures worked out by the localities are being used around the country to draw up lease contracts and to assess leasehold payments. Due to this, receipt of respective revenues into the budget is not ensured, and effective control of the use and safety of property held in Federal ownership is rendered impossible.
At any rate, legal instruments to regulate privatization in Russia are still far too weak. International experience shows that "privatization without adequate legal regulation and an effective juridical system facilitates criminalization of the economy". (11,32)
In Russia there is no single register of state-owned property, especially for shares and holdings and stakes belonging to the state. The databases in use are too sparsely filled and are not up to date. The data presented by official RF statistical yearbooks makes it impossible to assess the proportion and weight of enterprises in various forms of ownership, nor the role and importance of the non-state sector in the economy. There are no official comparisons of information in light of similar international practice.
The level of privatization in industry is higher than in the national economy as a whole. In 1995 the proportion of large and medium-sized non-state-owned enterprises in industry was 73.7 per cent of the total number of enterprises, and represented 84.6 per cent of total output. With small and joint-venture enterprises these figures were 85 per cent and 79 per cent, respectively.
For some subsectors of industry, the level of privatization comes to 90 per cent and over. Within engineering, the percentage of enterprises converted into joint-stock companies are as follows: automobile industry - 92 per cent; farm-machinery - 94.2 per cent; instrument-making - 85.1 per cent; machine-tool industry - 92.7 per cent; road building-machinery - 85.3 per cent; and chemical and petrochemical engineering - 91.9 per cent.
The relative level of privatization of small enterprises is higher than the level of privatization of the national economy as a whole, especially in the sphere of trade and public catering. The proportion of non-state-owned enterprises in the national economy as a whole comes to 96 per cent. In industry, where the proportion of small enterprises is 14 per cent, 93 per cent of these have been privatized. In agriculture, these figures are respectively 1 per cent and 84 per cent; in construction - 14 per cent and 95 per cent; in transport and communications - 2 per cent and 95 per cent; in trade and public catering - 49 per cent and 98 per cent; in housing and public utilities and in everyday services for the population - 1 per cent and 90 per cent; in science and scientific services - 6 per cent and 96 per cent.
The share of property under state control is considerably larger than the share of state-owned enterprises. By the beginning of 1996, the state had about 20 per cent equity in the pulp-and-paper industry, 15 per cent in metallurgy, 38 per cent in telecommunications, 55 per cent in engineering, and 42 per cent in oil and gas extraction. This is due to the fact that state-owned enterprises were mostly converted into joint-stock companies - 30,000 being created from 1992 to 1995. In any case, 10-30 per cent of them remain under substantial control of the state, i.e. the state owns over 25 per cent of the stock.
At the moment, a sizeable proportion of state property is dispersed among many privatized enterprises. This reduces the impact of the state on their management but also does not change the form of ownership among the largest and most asset-intensive enterprises. Joint-stock companies in which the controlling block of shares is held in state or municipal ownership are now very few in Russia - there are some 641, or just over 25 per cent. Joint-stock companies with a "golden share" number 392 or 15.5 per cent. (11,36)
Some specialists believe that the market price of vouchers was artificially depressed so as to buy up these vouchers from the people in an atmosphere of high inflation and get them into the hands of a few "privatizers". Indeed, that is just what happened. A study carried out by the SCP at 450 major joint-stock companies in 1994 showed that:
Thus, one of the social consequences of privatization in Russia is the fact that rank-and-file shareholders are being removed from enterprise management, while a handful of owners hold large blocks of shares. The influence of rank-and-file people on their own companies has not improved.
In addition, the possibility of receiving dividends on the shares held by employees (dividends which could make a difference to their well-being) is, for all practical purposes, insignificant because of the deepening decline in production, the crisis of nonpayments, and the loss-making nature of most privatized enterprises. Even where joint-stock companies do make some profit, they almost never pay dividends, using the money either to increase their authorized capital or to increase the volume of working capital and strengthen their financial condition, or to renovate fixed assets whose physical wear and obsolescence is a nationwide problem for Russia. By the end of the voucher privatization, Voucher Investment Funds (VIFs) designed to ensure the market reorientation of the least socially-active strata of the population, accumulated about one-third of the vouchers. The vast majority of these funds turned out to be low-income or loss-making. In the light of 1994 results, dividends were paid out by only 136 of the 646 VIFs (11,37).
The hope that non-state commercial organizations and foreign investors would become the main owners of former state-owned enterprises has not been fulfilled. With the exception of enterprises in raw-materials and fuel-and-power (and also some major enterprises in trade), the purchase of large blocks of shares was as a rule effected with the aim of subsequent resale in order to obtain speculative earnings. Here again, employees were left to the sidelines.
In the initial stage of privatization, the vast majority of privatized enterprises passed into the hands of their work collectives and VIFs. Seventy-five per cent of the enterprises converted to joint-stock companies in the course of voucher privatization opted for the variant providing for the handover of 51 per cent of the shares to the work collective. It is true that the transition to monetary privatization changed employees' attitude to this variant selected: in the second half of 1994, the aforesaid proportion dropped to 49 per cent, and by mid-1995 - to 44 per cent. (11,38) The work collectives and the VIFs had a stake mainly in receiving here-and-now financial benefits and not in any long-term development of enterprises. Accordingly, enterprises were not provided an effective owner and there was an outflow of investments due to funds being used to buy out shares in favour of management.
The process of secondary redistribution of ownership rights is now under way and its characteristic feature is the exclusion of employees and work collectives. It has run along two lines: (1) concentration of large blocks of shares in the hands of enterprise managers; and (2) buy-up of shares by commercial structures for speculative resale or for establishment of control of the cash flow of enterprises.
No wonder, therefore, that in spite of the optimistic mind set of the executive branch and a certain section of the Russian press, a majority of the population has taken a negative attitude to the process and to the self-evident results of privatization. The data offered by Russian and foreign specialists who studied this problem both at the start and at the height of privatization are almost entirely identical. According to public opinion polls held by the All-Russia Centre for the Study of Public Opinion, the proportion of those who believe that privatization has brought (a) benefits to their enterprise; and (b) benefits to them personally, has steadily declined (26 per cent and 21 per cent respectively in April 1993, and 12 per cent and 14 per cent in December 1994). According to Richard B. Dobson (Whither Russia? Trends in Russian Opinion Since 1991, Danvers, Massachusetts, 1994), the number of Russians believing that privatization (a) is being carried out incorrectly; and (b) was not needed at all has tended to grow (41 per cent and 13 per cent respectively in June 1991, 53 per cent and 15 per cent in January 1993, and 64 per cent and 22 per cent in September 1993). Roughly the same percentages would be found in public attitudes today.
These assessments are not likely to change in the near future because privatization has not gone to enhance social protection or to develop social infrastructure facilities, but has rather led to their destruction. The funds from privatization for the development of social infrastructure facilities have not been coming in. Enterprises and local authorities short of funds tend to give up these facilities which are then bought up by entrepreneurs for next to nothing and are re-profiled. There are many examples of transformation: sports halls into car showrooms and marketing warehouses; enterprises of cheap mass catering into elitist clubs, restaurants and boutiques; kindergartens and colleges into offices of commercial firms and banks.
The bankruptcy and liquidation of enterprises promotes lack of protection of the population. In view of the traditionally-vertical arrangement of Russian producer structures, the closure of even a small number of enterprises can bring about a heavy "chain reaction" for the entire economy because there is nothing to replace these enterprises. What is more, the monopolist enterprises as a rule employ specialists of a high and unique qualification whose skills are not easy to apply elsewhere.
The privatization of town-forming enterprises, similar to British and US "company towns" of the 19th century, is having specific social consequences for Russia. Examples here are provided by oil and gas complexes in the Urals and Western Siberia; the metallurgical giants of Nikel, Monchegorsk or Norilsk; the textile districts in the Upper Volga; the closed-town defence plants, etc. In such enterprise-towns, employees almost entirely depend on their employer and the loss of jobs for them signifies the loss of all earnings and benefits. This makes it clear why employees are prepared to be on the list of the employed even when they are, in fact, not working or are not receiving regular wages. Enterprise-towns used to provide Soviet citizens with social security and employment, and today they constitute a specific system of social guarantees in place of the old state system. Similarly, under the present system, enterprises themselves depend on their employees because the amount of state subsidies depend on the number of employees. Consequently, neither the enterprise nor the workers stand to gain from a reduction in the number of work places.
That is precisely why there are so very few bankruptcies and unemployment is so low in Russia today, when in a period of privatization and restructuring it would be natural for both to go up. Indeed, in order to compete successfully in market conditions, enterprises must relieve themselves of the costs of social security and subsidies and it would be quite right to close some of them down. However, this cannot be done when an enterprise has been purchased by its own work collective or by its present management. That is why some experts voice doubts about the effectiveness of Russian privatization as a whole, claiming, for instance, that "paper deals such as the voucher privatization programme imply that management is bound to behave differently if some outsider is in possession of the shares of their enterprise. Since the position of the manager does not depend on the amount of share capital issued into circulation, these are no more than pious hopes. The voucher programme is not backed up by any real standard of success in the work of Russian enterprises, and so cannot have an effect on the steam, smoke and sweat of the actual producer process". (9,10)
Indeed, one can be glad that privatization has not caused any real surge of unemployment. But, on the other hand, this is indirect evidence that for the time being its effectiveness is not very high. According to official data, the average level of unemployment in February 1997 corresponded to the "average European" indicator, namely, 9.5 per cent of the gainfully employed population. In the major agglomerations, such as Moscow and St. Petersburg, it is at a minimum at 0.4 per cent and 1 per cent respectively, but in small towns and areas where town enterprises are situated, it is up to 15-20 per cent. This difference in the figures shows that the social consequences of privatization need to be studied with due account of regional specifics.
One of the major conclusions of this study (12,90-127) was that privatization caused no fundamental change in the legal labour relations between employees and their enterprise. It has supplemented these relations with property relations. However, the actual conditions of workers at many enterprises have changed for the worse in view of the growing power of enterprise owners.
The study confirmed that the crucial factor affecting the condition of employees at privatized enterprises (and non-privatized enterprises) is the enterprises' financial state and the will of management. This is followed by the state of labour legislation and activities of trade unions, etc. Russia's labour legislation lags behind present day requirements, and fails to solve many problems connected with liquidation of state monopoly. The sphere and legal power of trade unions to influence regulation of industrial relations are lessening. There is an ongoing process to decentralize the legal regulation of labour-management relations - the state retains the right to establish the mandatory minimum level of labour rights and guarantees. These may be raised by collective contracts and other local legal enactments, and also by individual labour agreements (contracts) at the enterprise level. The demand today for "more market in labour laws" is aimed at not just more flexibility for employers, but also to create an attractive business environment for investors - especially foreign investors.
The study also showed that expansion of the freedom of enterprises in industrial relations is, on the one hand, good because it makes it possible to better use production potential, but, on the other hand, entails superfluous differentiation in the level of remuneration and labour conditions at different enterprises as a rule. This freedom is used by economically strong enterprises to improve the position of their employees because the manager wants to do so, the trade union is strong, and when there is substantial collective agreement. That is why the conditions of employees at "rich" enterprises are often better than before privatization. However, economically-weak enterprises are incapable of this and the conditions for these employees are worse than prior to privatization.
Newly-created private enterprises (especially small and individually-owned enterprises) are a case apart. Here, as a rule, labour conditions are determined arbitrarily and the rights and guarantees provided for by labour legislation are not observed. A characteristic example in this respect is provided by the Moscow limited-liability partnership called APIS (24 shareholders and 200 hired workers). Labour relations in APIS are covered by a contract which does not specify in concrete terms the mutual rights and duties of the parties. The employee merely agrees to work and to receive pay not below the minimum wage, while the rest is provided for in the enterprise statute. The motto of the limited-liability partnership is "maximum wages for minimum time". This enterprise has a six-hour working day and "good working conditions", but these indicators are attained by "discipline of the rod" and maximum exploitation of the hired workers. The enterprise operates without any lunch break and only a 15-minute break is allowed for tea during which meetings are held with management. The enterprise has a penal system in operation - a pieceworkers' wage is cut by 30 per cent for talking during working hours and for other misdemeanours. There is a trade union organization at APIS, but the only thing it does is collect membership dues. No collective agreement has been concluded. In the director's view, the substitute would be a "statute of partnership" wherein a person hired for work must sign his consent to work on the terms and conditions of this statute.(12,9) Why do the employees put up with this state of affairs? The answer is clear: earnings at APIS are much higher than in the region and the country's average.
The final conclusion of this study is the following: "It is an incontestable fact that the social protection of workers on the part of the state and the trade unions has been steadily declining. Such is the overall trend in the country. Some "islands" of relative wellbeing do nothing to alter this overall picture". (12,112)
From 1991 when "spontaneous" privatization got under way, to mid-1995 when large-scale mass privatization ended, Russia's GDP has halved; industrial production declined by 51 per cent; and engineering output by 65 per cent. Over the past two years, investments have been steadily shrinking and the stock index has gone down.
The authors of this paper are not inclined to ascribe the continuing economic recession exclusively to privatization because other unfavourable factors are having an effect on Russia's economy, and, if privatization had proceeded in civilized form, the results could have been different. One cannot deny the obvious facts either: the peak decline in industrial production at medium-size and large enterprises in 1993-1994 fully coincides with the peak indicators of privatization of industrial enterprises.
Instead of taking gradual steps towards effective privatization based on a principle of success, an attempt was made to create a perfect system overnight without any thought given to probability of success. The hasty "marketization" carried out in this manner instead of real privatization has done little to change the economic behaviour of enterprises. At the same time, there was a fragmentation of single technological complexes and a breakup of cooperation ties. The old system of economic management was destroyed but no new and effective institutional mechanism was created - a fact that has had a particularly painful effect on technology-intensive production which has declined by 70-80 per cent.
The negative macroeconomic consequences of privatization are most clearly discerned in high-technology, science-intensive, deeply integrated lines of production currently in a state of stagnation. Their privatization leads to a massive drain and a virtual give-away abroad of the latest high technologies and unique scientific and technical achievements. On the whole, the West has acquired such a large volume of new technologies in Russia that NATO mounted a special programme for processing these technologies.
When industrial complexes are privatized, the research institutes, design bureaux, and pilot and experimental lines of production that form an integral part of them are sold off separately. This breaks up the connections between science, pilot and experimental production and basic production, and sectoral science tends to lose financial support and is either destroyed or begins to work "for export". The farm-machine industry and the automobile industry, to name but two, may well serve as examples.
This kind of privatization has inflicted much harm on Russia's sea and air transport where privatization-driven fragmentation has led to a reduction of controllability, safety and uninterrupted operation. For example, civil aviation now has about 400 independent companies, six of which handle 40 per cent of the capacity, 20 are barely viable, and the rest have from one to three aircraft in ownership.
Among the reasons for negative macroeconomic aftereffects of privatization, one should be aware of the wrong interpretation of "monopolism" and the incapacity of antimonopoly legislation in Russia. In the struggle against monopolism, the establishment of holding companies and financial-industrial groups was limited. But the absence of control on the securities market led to the formation of new monopolists, including some of foreign origin as in the aluminium industry.
All this provides convincing evidence that the failures and negative consequences of privatization in Russia come mainly from a failure to observe an important rule: privatization, especially of capital-intensive industry, requires vast preparatory work in what is known as restructuring. Today, despite the fact that the massive privatization campaign is almost at an end, one must get down to this difficult and labourious task. There must be an end to massive, forced, and cheap sale of state property with a switch to piece-by-piece privatization. At the same time, the fiscal function of privatization should be replaced and funds earned from it should go to restructuring and renewing privatized enterprises.
The one-way movement towards de-nationalization needs to be converted into a balanced process of ownership transformation. The underlying criteria should not be political considerations but economic effectiveness, the country's strategic interests, a rise in people's living standards, observance of laws and, finally, the principle of equality in all forms of ownership. Most failures in privatization in Russia stem from ignoring world experiences, information on which is vast and easily accessible (see sources 8 and 14).
The primary and most important aspect not assimilated by Russia was that privatization should be carefully prepared, agreed upon by the main stakeholders and jointly implemented. The following pre-privatization measures require time:
The second rule generated by world experience is the need to observe the sequence of privatization: movement of industries in which requirements of capital per unit of product are the lowest and where direct participation by the owner in enterprise affairs is greater (trade, services, light industry) than the more capital-intensive industries (metallurgy, engineering). Such a sequence will help small and medium enterprises accumulate financial and entrepreneurial experience; generate new ideas and managerial skills; create new work places; and raise funds for new enterprises to privatize larger industries which must be restructured into viable and effective firms.
The third rule is that only competitive, efficient and well-managed enterprises must be privatized. An enterprise that is insolvent must not be privatized but liquidated.
Finally, the fourth rule is that during transition the state's role in regulating the economy must not be reduced - it must, on the contrary, be increased. During this period, the state must do everything to support the business and institutional infrastructure and a conducive environment.
Of the three closely interdependent factors determining the effectiveness of human industrial organization: (1) the level of industrial development; (2) ownership relations; and (3) the prevalent mind set, the first is the most dynamic. Ownership relations tend to change more slowly. Mass mind set is the most static as it is based on ethnoculture which takes shape over the centuries. The need to coordinate these three factors is crucial and attempts to ignore them may lead to opposing results. That is exactly what happened in Russia.
In this regard, it is necessary to take a serious look at this craving for economic democracy and self-government now typical in Russia. Besides the influence of ethnoculture, including religion whose importance in Russia is beyond doubt (see 18,4-5), Russia's industry is dominated by work places which objectively limit the economic and social outlook of the workers - 40 per cent of whom are engaged in low-skilled manual labour. The overwhelming majority of Russia's workers are hired labourers incapable of developing the "sense of ownership" being suggested to them. Finally, the dominant element in the mass mind set is the belief that everything will be sorted out "up there" and that all one has to do is elect a "good" president to bring well-being to each family. The swanky escapades of Russia's Liberal-Democratic Party leader, Zhirinovsky, are met with a grin by reasonable-minded people. But the fact that some 15-20 per cent of Russia's electorate regularly vote for Zhirinovsky even makes them think again about Russia's mass mind set.
It is also true that there are other enterprises and industries in Russia whose managers' cultural level and knowledge of employees, together with the changing ownership relations, create real prerequisites for successful reforms. This should be the starting point for designing and implementing optimal forms of economic democracy. For some work collectives the representative form is preferable, and for others - the direct form. Incidentally, the potential for a representative democracy in Russia is far from depleted due to the lack of real trade unions creating tension between themselves and management. In most market economies they act as a motor of social and economic progress. Collective-agreement practices in Russia are still at an early stage.
Another element hampering the development of new forms of market-oriented management in Russia is the destructive "social fatigue". There is a widespread misconception among specialists and the public that resistance by some strata of the administrative system (the old "nomenclature") is the main obstacle to reform. Indeed, for them the transition to a market economy and the principles of self-regulation signify a loss of power and privilege. But it would be simplistic to try to divide Russian society into a "reactionary officialdom" and "progressive masses of employees" which is a far cry from the real state of affairs.
The point is that measures used in forming a market economy, the perestroika of ownership relations, and the change of views and attitudes to wage labour have not always been met with a positive social assessment. A large portion of Russia's population (as in other CIS and Eastern Europe countries) continues to take a passive and often negative attitude towards reforms for several reasons, notably; disappointment with reform results; irritation with the promised expectations of a rapid improvement to living standards; discontent with the decline in living standards caused by structural transformations, and the like.
These social problems put more obstacles in the way of reforms than does resistance by bureaucrats. The latter, incidentally, are quite aware of this fact. While fighting for their own interests they are also on the lookout for allies and do not merely hamper the efforts to overcome reactionary stereotypes in the mass mind set, but in fact use any occasion and method to whip up social tension.
The task of political and trade union leaders as well as academia is to help employees realize their own interests and find possibilities for improving their living standards. Finally, in view of the pressure on the state to raise living standards, attempts which pose a real threat to economic and social destabilization, it is important to dispel the myth that enhancement of well-being is mainly determined by political decisions.
Economic restructuring and privatization inevitably lead to an infringement (even temporary) of personal and group short-term interests. That is why resistance to such decisions, social tensions, and a decline in public morale are natural occurrence. Therefore, while continuing market reforms and privatization the following must be ensured:
(a) a combination of requirements of economic rationality and basic human and social values, as well as better social control of reform results; and
(b) an effective consideration of employees' interests in determining and attaining the economic policy goals.
There is no documented declaration on the part of Russia's Federation of Independent Trade Unions reflecting its clear-cut and unequivocal stand with respect to privatization. Hence, the authors have used the results of studies carried out by the Research Centre of Russia's Trade Unions (2,12), publications of trade union researchers (18), and materials circulated by Russian trade unions at the Thirteenth World Congress of Trade Unions (5).
Let us note that the communist "taboo" was lifted from the discussion of alternative forms of ownership some ten years ago when Gorbachev's perestroika put forward slogans of social and production self-management. Even then ideologues of Russia's trade union movement, while recognizing the principle of pluralism of ownership and simultaneously believing that the work collective should have a stake in production, raised the question of bringing "forms of ownership into conformity with self-management, something that requires transformation of state property into group collective property". (18,1) While approving the transition from state ownership to employee ownership through leasing individual, family, cooperative, collective, and joint-stock forms of property, they - even at that time:
Russia's trade union views concerning employees' growing alienation from ownership were the following: "The way out seems to lie in the democratization of ownership. It must be in the possession and under the management of those who can and want to do this. Individual, family, cooperative and collective property has every right to exist. This property is in the possession of the people, at the disposal of the local Councils and under the management of the leaseholder".
"Among the leaseholders one may find individuals, groups, families, public organizations and work collectives vested with the right to buy the enterprise and put it under collective ownership. Only the land cannot be put up for sale. The state must also become a leaseholder through its departments. This is the only way to put an end to dictatorship".(18,10)
The changing stand of Russia's trade unions at the various stages of privatization
It is clear why trade unions welcomed the July 1991 USSR Act on the Principles of De-Etatization and Privatization of Enterprises. After all, the original idea of transforming state ownership into private ownership was based on the priority of work collectives and citizens to acquire property before foreigners. The leasing of enterprises to work collectives with the right to buyout was envisaged as a means of privatization.
The Act proclaimed the citizens' right to become owners of industrial property and results of production based on diverse forms of ownership. Special emphasis was given to social protection - equality in receiving a portion of the property subject to privatization. The work collectives were given the right to choose the form and determine the rules of privatization.
The Act gave work collective members the priority to acquire property as a result of its privatization. The work collective was also given the right to privatize a state-owned enterprise or to lease it. It also envisaged considerable benefits for work collectives in their buyout of state property: to transfer part of the profit to employee ownership; free transfer of ownership or use of various production facilities or social infrastructure; and sale of shares and property in installments at low prices. It also stated that worn out property could be transferred to work collectives free of charge.
The conception of the Act coincided with the trade unions' stand on transformation of ownership, and was enthusiastically accepted. However, this enthusiasm was short-lived. With the disintegration of the USSR, each CIS country opted for its own way to privatize, and very soon substantial differences emerged. Russia became the leader in scale and pace (including coercion and haste) of privatization. Under the new RF legislation, the work collective lost many benefits and advantages in the privatization process.
As for medium and large enterprises (the basis of the trade union movement), RF legislation provides for their conversion to publicly held (open) joint-stock companies. It is forbidden to create closed joint-stock companies where shares are purchased mainly by employees of the enterprise and where, the trade unions believe, it is possible to blend the interests of the work collective as owner and employee. (5,7)
Another factor causing dissatisfaction among trade unions is the lack of prohibition on the issue and sale of shares of loss-making enterprises. With the emission of vast quantities of shares, the absence of any kind of restriction inevitably shifts the responsibility of future loss-making and low-profit enterprises (which are a majority in Russia) onto the shoulders of shareholders and employees.
The trade unions are also concerned that the distribution of shares in work collectives is not in the favour of rank-and-file employees. Management of most equitized enterprises has been able to concentrate on one-fifth of the voting shares, and often the controlling blocks of shares as well, while rank-and-file employees have only bought out one-third. If one takes the shares bought out by the work collective (51 per cent of the authorized capital) as 100 per cent, in 1994 the management of enterprises accounted for 40 per cent of the shares, and all the other employees - for 60 per cent (5,8). Since then, things have moved in one direction only as shares are being bought up from rank-and-file employees. This has even been provoked illegally by means of deliberate delays in the payment of wages.
The objective of voucher privatization was to create a broad stratum of share buyers but it failed to meet the wishes of employees and trade unions. Firstly, vouchers could only be used to purchase shares of state-owned enterprises, narrowing the range of investment. Secondly, vouchers were not inscribed thus encouraging manipulation and many of them falling into the hands of unscrupulous nouveaux riches. Thirdly, it was not permitted to redistribute people's property in such a way "that ships passed into the hands of ship workers, and banks into those of bank employees". Most Russian citizens working in areas not due to be privatized (doctors, military personnel, etc.) were forced to exchange their vouchers for certificates of emerging commercial structures, so-called voucher investment funds. Many of these funds (MMM, Germes, and others) were in fact fraudulent financial pyramid schemes. All of this put into question the future of vouchers of millions of Russians.
The problem, according to trade unions, is that present-day reformers fail to align their actions along the historic lines of development of ownership, but proceed with the false assumption that private ownership remains in its primordial form, without undergoing any change whatsoever. In the evolutionary development of the economy and society, ownership and its functions underwent a change - they keep changing, and will continue to change. Sooner or later man, who once sold his labour as a commodity, will become a co-owner.
Upon the adoption of the decision to set-up leased enterprises in the USSR, their number grew rapidly. Worker discipline and organization was tightened and a sense of responsibility for the enterprise developed. Sociological polls confirmed the positive changes. In response to the question: "What has your enterprise achieved as a result of leasing?", 56 per cent noted an improvement in income; 39 per cent an improvement in labour discipline; 19 per cent greater involvement of employees in solving enterprise problems; and 17 per cent the elimination of compensation levelling (5,15). Employees support leaseholding due to the following reasons:
Bought-out leased enterprises have acquired, in conformity with RF legislation, closed joint-stock companies and limited-liability partnerships, and enterprises whose shares belong to individual employees. Consequently, these enterprises have individual employee ownership under a collective management whose main assets are:
This form of economic democracy has proved to be effective and superior as compared with state-owned enterprises and open joint-stock companies. According to 1993 data, closed joint-stock companies and limited-liability partnerships had an average capacity 10 per cent higher than that of state-owned enterprises and open joint-stock companies. Forty per cent made no investment in the development of their enterprises at all, and only 10-12 per cent increased their investment. At the same time, 70 per cent of closed joint-stock companies made investments, and 22 per cent invested on an ever larger scale. A relatively smaller proportion of closed joint-stock companies reduced output of their core products (40 per cent, as compared with 50 per cent among SOEs and 54 per cent among open joint-stock companies), while a greater proportion (respectively, 22 per cent, 16 per cent and 17 per cent) boosted the volume of their production. There is a similarity with other indicators, including self-financing and cost-cutting (5,18).
In accordance with the Privatization Act, leasing of state-owned and municipal enterprises ended and leased enterprises not bought out by work collectives were transformed into open joint-stock companies or sold at auctions or by tender. Most of the "belatedly" leased enterprises were privatized in accordance with the second of third variants of incorporation provided for by the State Programme (the first was advantageous to management, the second to work collectives and the third to outside investors). The same second variant was also applied to most industrial enterprises. This democratic variant proved to be effective, as seen from the results of a comparative analysis of economic and financial indicators.
In 1996, the Leontief Centre (St. Petersburg) made a comparative analysis of results of three types of Russian enterprises (state-owned, "medium-privatized" and "deeply privatized"). The authors are not entirely in agreement with the methodology and general conclusions of this study, but one must agree with the following: "The group of enterprises equitized in accordance with the second variant, ... is a clear leader by economic indicators. This is confirmed by the fact that the variant under which employees' interests are realized has turned out to be the most effective one". (17,99) A comparison was made between 1,419 industrial enterprises. Those equitized under the second variant were ahead of the rest on all economic indicators (labour productivity, profitability, etc.), except for yield per unit of assets because, apparently, they did not sell their property immediately after privatization.
Russian trade unions regard employee ownership as an alternative to the Government's approach to transferring state-owned property to private capital. This alternative has many opponents whose main argument is the uncompetitiveness of collective ownership.
This way employees may acquire shares over a number of years at a price fixed by ESOP without having spent any savings or wages and without the cost of intermediaries and other services. Upon payment of the stock acquisition loan the employee becomes a full-fledged stockholder.
Over 11 million employees in the United States have taken this path to becoming co-owners of companies. The ESOP model is applied by 12,000 firms with assets totalling US$120 billion and employing 13 per cent of the country's work force. Other such models can be found in more than 70 countries around the world.
Russian trade unions believe that transforming joint-stock companies into individual employee ownership enterprises under ESOP could also be carried out in this country. ESOP is also appropriate for cooperative enterprises where economic democracy is an integral part of management. In developed countries, much experience has been accumulated during the cooperative movement in agriculture, trade, construction, fisheries, insurance, and banking. Recently, the number of cooperatives in industry has also grown. One of the leading countries in the development of cooperatives is Italy where up to 9 per cent of the working population is employed in cooperatives. The author of RF trade union alternative (5,25) exemplifies this with the major Italian cooperative financial and production association MONDRAGON, which brings together almost 100 cooperatives of various kinds and has been developing successfully for several decades. MONDRAGON's prosperity is due to the interest of cooperative members both as wage workers and as owners. According to trade union experts, cooperatives are capable of producing a stable output of competitive products and are an alternative to capitalist enterprises in many sectors. They are also considered to be democratic, ensuring members' economic and social protection.
Cooperative ownership may be regarded as the "third way" to economic development (the first two being private and state ownership). It is believed that cooperative ownership can and must withstand the competitive struggle against private capital and firmly establish itself in the market as one of the basic forms of management. However, it must be given public, legislative and financial support by the Government.
One way of creating employee ownership enterprises in non-ESOP countries, is the buyout of stock by employees of open joint-stock companies. First, consolidate ordinary stock held by employees into a single block in order to establish an independent closed joint-stock company. Its main activity will be managing the stock of the open joint-stock company. The aim of the new company would be to transfer the capital of the open joint-stock to the employees. Ideally, the entire stock would be bought up and the open joint-stock company taken over by the closed joint-stock company. If not, it would be possible to take hold of a controlling block of shares with the ensuing consequences.
The process of such transformations is complicated and requires special knowledge and experience. To assist enterprises with individual employee ownership the International Organization of Enterprises with Employee Ownership was set up in Russia in 1992. It operates successfully and has among its members some well-known organizations such as the Association of Enterprises with Employee Share Ownership (Belarus), and the Kelso Institute for the Study of Economic Systems and the Oregon Steel Mills (USA).
Trade unions could also help employees become owners of open joint-stock companies. In contrast to US labour unions which give large-scale financial support to their members (i.e. the buyout of a steel company by its employees), Russian trade unions have very limited possibilities. However, Parliament is working on the adoption of legislation to create favourable conditions for employees to buyout their enterprises.
As many Russian economists believe, the cooperative movement in Russia has vast untapped reserves. There is huge potential in the consumer industries (agriculture, for example), as they offer the combination of a traditional Russian collectivist approach and free private initiative. However, this freedom will only emerge at the end of privatization when each property and every square inch of land in Russia has an owner.
One can claim that this goal has now been attained at an unprecedented pace and scale. The state has in fact removed itself even from use of the rights of ownership not transferred to private persons. The lifting of obstacles in commercial activities of officials - those within agencies of executive power and in management of enterprises nominally remaining in state ownership - has flung open the doors to embezzlement and plunder of state property through joint efforts of both the privatized and nonprivatized sectors of the economy.
Privatization in Russia has succeeded in dismantling the mechanisms of a centralized economy. But it has provided a small group of people with the possibility of unlimited disposal over national property - a disposal partially achieved by right of title of ownership passed onto them. It was also done by gaining actual control of the equity of enterprises rather than this being passed out among the millions of rank-and-file shareholders.
This kind of privatization could not of course ensure the creation of responsibility by private persons in business practices to replace the mechanism of responsibility by management of state enterprises within an economy run by directives. As a result, the image of the "effective owner" as the central figure of the advertising campaign to back up the Government's line on privatization proved to be no more than a mirage.
A false goal was set from the very outset. Instead of creating conditions for free commerce and property rights, emphasis was placed on the "distribution of property" and the mere transfer of the title of owner. This was supported by a dogmatic notion that the main problem in ownership relations is merely title of ownership or possession.
First, the loss of governability from the top has been so extensive that it cannot, in principle, be compensated for rapidly at the enterprise level even under the most favourable circumstances. Second, general conditions in Russia are still highly unfavourable and they hold back the development of market institutions. The basic functions of management cannot be simply delegated from the top down - something must also be passed from the bottom up. This "something" is a fundamental concession on the part of businesses to cooperate with the state in attaining national goals and a voluntary limitation of freedom to pursue private interests for the sake of social interests. The development of institutions that can orient the activities of the entrepreneurial community is a common feature of the socioeconomic evolution of countries with highly developed market economies. The effect of such institutions is also broadly similar to that described above. It is safe to say that these institutions serve as a counterweight to the otherwise potentially destructive factors rooted in market mechanisms to a much greater extent than in direct state regulation of the market.
Cooperation between the state and the entrepreneurial sector (along with social partnership), is usually connected with so-called "corporativism". Corporativism, as a system of social responsibility of business, can have significant yield only in tandem with mechanisms for its economic responsibility. Good intentions of "serving society and the nation" are realized mainly for one's own risk, and on one's own responsibility; otherwise corporativism cannot be viewed as benefit other than a consolidated cooperation of a bureaucratic class and a financial elite.
Present conditions in Russia confront us precisely with such a phenomenon, while the ideal of a "benevolent corporativism" remains a myth. To Russians it appears more attractive than liberal-monetarist myths. But doctrinal conflict between classical liberals and advocates for a revitalizing of a mandate-managed economy is being increasingly drowned out by a growing chorus "for the idea" of corporativization of Russian society. At the centre of the respective programmes and political trends claiming to play a role of integrator of social forces (for which extreme radical attitudes on both sides are unacceptable), stands the need to consolidate the economic and political interests of the state and those of the major centres of economic power in the privatized sector. To attain this, the state must do everything to promote the formation of such centres and the development of their influence under its won oversight and control.
There was much in favour of state support of enterprises at the beginning of privatization. It was something expected to bring about a turning point in the economy. However, under present conditions and in the absence of a favourable investment climate, the bulk of resources directed by the state has been appropriated by a group of corrupt officials, many of them preferring then to ship these "privatized" resources abroad.
The auction/tender barrier between the state, private sector and administrative control of state enterprises, will provide protection for the budget. All transactions in which the state is vendor must be carried out through public auctions. All transactions in which the state is purchaser must be carried out through competitive tenders. This will help narrow down the possibility of bureaucrats making dishonest deals with the private sector. Also, auctions will increase revenues for the treasury because state goods and properties, including leasing, licenses, and quotas, will be sold at the maximum price. Treasury expenditure will reduce with the competitive tender as it will attract suppliers or contractors capable of providing quality at low prices. Halting the practice of financially supplying private enterprises should also protect the budget against useless expenditures.
The problem lies in distancing the state sector from the private sector with minimum (acceptable) losses to structural-investment priorities. With the formation of an effective entrepreneurial community and a favourable investment climate, mutual relations between the sectors could be improved. The state should structurally reform the private sector using indirect methods, such as investing state resources in key infrastructure important to future modernization; selling the rights to the private sector to use these networks; and forming a favourable investment climate and easing the conditions for an influx of private resources into priority segments of the economy.
This has been the new emerging force in the Chinese national economy since 1979. Up until the end of 1995 about 190 million people were employed in the non-state-owned sector - nearly 2/3 of total employment, excluding agriculture (China Statistical Yearbook, 1996). There is no doubt that non-state enterprises have played a very important role in China's economic reform. The process and perspective of development of this sector are a key issue in understanding China's economic development today.
In the first part of this chapter, a brief history of the economic development of The People's Republic of China (PRC) is presented. In the second part, the actual process of the emergence and development of the non-state sector since 1979 is described and its different aspects discussed. New policies and strategies of central and local governments to encourage development of non-state enterprises; the improvement of the macro-economic environment relevant to their development; and the role of the non-state sector in China's economic reform and its perspectives are all discussed.
The third part of this paper provides case studies of five non-state enterprises: The Golden Wheel Group, which is the biggest manufacturer of cord fabric in China, now also producing motorcycles; Hengdian Group - one of the three biggest township enterprises in China; Dynasty Group - a Sino-French joint-venture producing high quality wine; Galanz Group - the biggest supplier of microwave ovens in the domestic market and perhaps the only Chinese manufacturer to have won over competition from joint-ventures; and Star Insulation Materials Company which is restructured from a state enterprise to an employee-owned enterprise and is supported by the local Government. These five cases cover different industries and regions and are typical representatives of the development process of non-state enterprises. Finally, the conclusions explore future perspectives of the non-state sector in China.
3.1 A historical review: the economic system before 1978
The PRC was founded on October 1st, 1949 after eight years of war against Japan (1937-1945) and three years of civil war against Kuomintang (1946-1949). The new Republic inherited a collapsed economy with an astronomical inflation rate.
Facing such problems, the central Government's first priority was to restore the national economy. This period (1949-1952) was called Restoration of National Economy. The strong leadership in the social, political and economic fields focused on the development and use of material, financial and human resources. Within three years inflation was reduced through currency reform measures, the national economy gradually improved, and unemployment somewhat lessened. Based on these improvements, China implemented its First Five-year Plan of economic development (1953-1957).
At that time China had very limited financial and material resources, with a shortage of skilled labour to meet economic development needs. This plan enabled China to focus on key industries, areas and projects. Sectors such as automobiles, aviation, shipbuilding or heavy machinery industries, as well as energy generation, were established in the mid-1950s and provided the basis for further industrial development. China followed the USSR model of command economy in all aspects of management both at the macro- and micro-economic levels. The First Five-year Plan resulted in higher productivity, enhanced economic capacities and improved standards of living.
China, however, retained different types of ownership until the first half of the 1950s. Besides state enterprises, there were private companies and a large self-employed population (informal sector). In 1956 a nationwide campaign for a "socialist transformation" began. The Government purchased all private companies and transformed them into state enterprises. Self-employed workers were organized into collective enterprises. By 1978, there were only two kinds of ownership in China: state enterprises and collectively-owned enterprises (only in urban areas).
Whereas in the early years of the PRC when the concentration of limited resources in key economic sectors through central planning proved to be positive, with further economic development the defects and negative impacts of this system became more and more obvious.
Under the centralised planning system the Government dictated what and how much enterprises should produce. The produced goods were then distributed through government channels at fixed prices. Managers of these enterprises were totally indifferent to the quality of the products, how they were sold or whether it was at a profit or loss. No matter how much profit they made or how big the loss, it was the Government not the enterprise that would benefit or cover the losses.
All state enterprises "ate from the same iron bowl of the Government" no matter how they performed. Economically-different enterprises were provided with the same budget and the same wages. Managers and workers were not motivated to achieve higher productivity and better performance. The same "iron bowl" relationship existed between the enterprises and their employees.
Employees of state and collective enterprises were employed for a lifetime. The enterprise had not only to pay them a monthly salary, but also take care of housing, health care, pension, and schooling, etc. Employees' pay was not based on performance and contribution, but on standards imposed by government. No matter how well one worked one received the same pay with no risk of dismissal even for bad behaviour.
It has become clear that these two "iron bowls" were a serious hindrance to organizational and employee motivation. Overcoming these obstacles has become one of the key issues in China's economy.
3.2 The emergence and development of non-state enterprises
In 1982 a development strategy to quadruple the GNP from 1980 to 2000, and by the mid-21st century to complete modernization to become a middle-income developed country was proposed in China. The transition from a planned economy to a market-oriented economy has experienced several stages of conceptual understanding. In 1982 the central Government changed its view of the economic policy by assigning the centrally-planned economy a major role and market regulation a supplementary role only. However, after the successful reform in the rural areas in 1984, it was decided to extend market-oriented reform to the national level, with emphasis on the urban areas. China's economy was considered at that time as a planned commodity economy based on public ownership. In 1987 the conceptual view changed again: the economic system and its operational mechanism started to be considered as equal integration of a planned economy and market regulation.
Only in October 1992, after more than a decade's experimentation and experiences, did China clearly put forward the objective of an economic reform system - to establish a socialist market economy. Under this system, the public and private sectors have equal rights to exist. All state-owned, collectively-owned and non-state enterprises should compete with each other in the market on equal terms. The new policy stressed active promotion and development of non-state enterprises as a major part of economic reforms.
Due to improved productivity, the surplus in labour force became more apparent. To prevent this surplus from moving to the cities and causing chaotic urbanization and increased unemployment, township enterprises were allowed to be set up. These township enterprises rapidly expanded in the vast rural areas and played an important role in China's economic reform. Some of them were actually fully private enterprises though they call themselves collectively-owned enterprises. These peasant enterprises not only provided numerous new jobs but also greatly improved the income of farm-workers since the industrial products they produced had much higher added value. Improving the workers' income also benefited the local Governments and brought many peasants closer to industrial society. The emergence and development of large amounts of township enterprises in the Chinese rural areas was an important contribution to the reform process.
This provided additional pressure on the central Government to dismantle the centrally-planned economy and to speed-up restructuring. The development of the "tertiary" industry and various types of ownership had also become an objective of the economic reform. Self-employment was particularly encouraged in cities to reduce the unemployment problem. This was actually the beginning of emerging private property in cities.
Chart 1:Total revenue of the central and local Governments
Source: China Statistical Yearbook 1996
Note: CG ---- Central Government
LG ---- Local Government
At the same time commercialization of the banking system was not so successful because enterprises and banks were state-owned and a vicious economic circle emerged: state enterprises could not pay back loans - the banks' capital eroded and profits shrank, and, as a result, loans to state enterprises were limited. The Government's reduced revenue from taxes diminished its ability to reinvest in state enterprises and, consequently, state enterprise development suffered. At the local level, small and medium-sized state enterprises controlled by local authorities also had difficulty in getting bank loans and the local Government had to find new methods to support economic development. Encouraging and developing the non-state sector had therefore become a major way to overcoming financial difficulties for local Governments.
The concept of "collective ownership" was adopted by China from the USSR in the 1950s in two forms: The first was the "People's Commune" (a type of "kolkhoz" in the USSR) in rural areas, and the second was "the socialist transformation" of small private enterprises (e.g. self-employed workers), as well as "the movement of housewives" which mainly covered service and light industries in urban areas. Prior to 1978 all enterprises belonged to state or collective ownership. The evolution of these two forms of property have provided some impact on further ownership reforms.
Firstly, township enterprises were considered as collective ownership because private property was not allowed at that time, though most township enterprises actually operated as private companies. Secondly, all collectively-owned restaurants, barbershops and other service enterprises were so inefficient and the quality of their services so poor that they could not compete with the newly emerging small enterprises based on self-employment. Large numbers of these collective firms gradually disappeared or transformed to private ones during the 1980s. Past official statistics for collective enterprises could now be accepted as statistics for non-state firms.
Chart 2: The ownership structure (1978)
Source: China Statistical Yearbook 1995
Note: COE ---- Collectively enterprises
SOE ---- State enterprises
Chart 3: The ownership structure (1994)
Source: China Statistical Yearbook 1995
Note: COE ---- Collectively enterprises (including township enterprises)
SOE ---- State enterprises
IOE ---- Individually-owned enterprises
OOE ---- Other enterprises (joint-ventures, shareholdings, foreign funded and overseas Chinese)
Companies with different types of ownership had difficulty in competing on an equal basis in the same market since state enterprises relied heavily on government support. Moreover, state enterprises traditionally had a heavy social burden. Due to the poor social security system and underdeveloped labour markets, these enterprises could not lay off their redundant labour force. Many of these enterprises were founded several decades ago and have retirees to pay for. In addition, the managers lack the necessary competence to operate under market conditions.
Non-state enterprises operated within the market without any preferential treatment or protection from the Government. Their existence and development largely depended upon their own efforts. Mobility of the labour force was acceptable and employees were recruited under contract. These companies were relatively young, flexible and without traditional social burdens of state enterprises. More important, they were far less controlled by the Government and could enjoy much more autonomy in running their business. This partly explains the contrast in performance of enterprises with different property structures (see table 1, 2).
Table 1: Growth rates of GDP and industry (%)
| 1978 | 1985 | 1990 | 1992 | 1993 | 1994 | 1995 | |
| GDP | 11.7 | 13.5 | 3.8 | 14.2 | 13.5 | 12.6 | 10.5 |
| IND of SOS | 14.44 | 12.94 | 2.96 | 12.4 | 5.7 | 6.5 | 8.2 |
| IND of NSOS | 10.58 | 63.04 | 23.15 | 52.34 | 63.49 | 51.8 | 34.6 |
Source: China Statistical Yearbook 1996
Note: IND of SOS: Proportion of state-owned sector in gross output value of industry
IND of NSOS: Proportion of non-state-owned sector in gross output value of industry
Table 2: Economic indicators in 1995 (Million yuan, RMB)
| Number of Enterprises | Employment (Persons) | Gross Output of Industry | Total Property | Long-term Liability | Total
Pre-Tax Profits | |
| SOS | 118,000 | 112,610,000 | 3,121,966 | 4,747,206 | 1,122,977 | 287,416 |
| NSOS | 8,453,500 | 189,470,000 | 6,067,408 | 3,176,180 | 452,984 | 217,617 |
Source: China Statistical Yearbook 1996
Note: SOS ---- State sector
NSOS ---- Non-state sector
Very high GDP growth rate since 1978 (table 1) depended strongly on a rapid growth of the non-state sector, while growth in the state sector decelerated. Table 2 shows that non-state enterprises provided 3/5 of jobs in China - many more jobs than provided by the state sector. The financial contribution made by the non-state sector was almost as much as that of the state sector but its debts were much lower. The non-state sector became a major contributor to China's market economy and in future will play a much more important role in the national economy.
3.3 Case analysis
The cases below reflect actual restructuring experiences of five large private and township enterprises.
In the next seven years four new manufacturing facilities were established with nearly 3 hundred million yuan invested. By 1993, the factory had captured more than 40 per cent of the domestic market in cord fabric and had become the biggest supplier in China, successfully competing with other enterprises, including state-owned ones.
In 1994, The Golden Wheel Group diversified again. First came the production of motorcycles with annual output reaching 300,000 by 1996. Today, The Golden Wheel Group produces chemical fibre, textile, machinery, electronic and metallurgy products. Total capital assets have reached 2500 million yuan (RMB). A few interesting lessons could be learned from The Golden Wheel Group's restructuring experience.
Also, compared with state enterprises, township enterprises like The Golden Wheel Group have much more freedom to build up their internal management system according to business necessity and by ignoring the standards of central Government in this regard. They can design their own organizational structure and decide on their own personnel policies and salary systems, etc. The Golden Wheel Group was divided up into 29 branches according to products and functions and introduced a contractual system between the branches to headquarters. This arrangement secured more time for headquarters to concentrate on long-term corporate development strategies and provided more autonomy to the branches to make operational decisions.
Firstly, they advertised throughout the country searching for high quality managers, engineers and skilled workers. Attractive positions, relatively high salaries and welfare benefits were offered. Secondly, creativity and openness to a permanent flow of new information from the outside was encouraged. Well-known managers, entrepreneurs and experts, both local and foreign, were invited to give workshops and seminars on the most important issues in management and business practices. Thirdly, a training centre was created to provide on-going training of managers, specialists and workers. In-house training was combined with short-term outside training programmes, for example at universities, when necessary.
The Golden Wheel Group greatly benefited from these policies, and the quality of human resources rapidly improved to meet the demands of the new competitive environment. The Group's experiences have shown that non-state enterprises can compete successfully with state enterprises, thus encouraging the development of other non-state sectors in the area and generally improving the local economy. One of the shortcomings of the Group's development was its heavy reliance on an authoritarian leadership. Under pressure to diversify, it has become more and more evident that more delegation and decentralization should be introduced to use improved human resources and managerial personnel more effectively.
In the beginning, a series of policies were introduced to make the Group commercially independent from the local Government in order to separate commercial decisions from public administration processes by the local authorities. This was an important achievement and a condition to the future success of the Group. The basic objective of the Group was town development and income generation for its population. Its main principles were common ownership, creativity and wealth.
Within 12 years the Hengdian Group had turned around the local economy by considerably improving the standards of living and supporting the town's development towards a modern industrial society. Table 3 provides data on industrial growth since 1985. Output of the Hengdian Group reached 3800 million yuans RMB in 1996 which is more than some large state enterprises in China. About, 70 per cent of the population was employed by the Group, thus impacting almost every family in the town. Today the Hengdian Group is one of the three biggest township enterprises in China.
Table 3: The growth of industrial output of the Hengdian Group
(Million yuan, RMB)
| Year | 1985 | 1990 | 1991 | 1995 | 1993 | 1994 | 1995 | 1996 |
| Output | 35 | 180 | 305 | 600 | 1080 | 1760 | 3000 | 3800 |
Source: Documents offered by Hengdian Group.
Today the Group consists of 12 domestic industrial companies, 3 international companies and one import-export company. It also supports almost all social and infrastructural developments in the town. For example, it provides a social security system to its employees and supports the development of the town's social infrastructure through different foundations, such as the "Foundation of Pensions", the "Foundation of Health", the "Foundation of Education", and the "Foundation of Public Goods", etc. All of them were founded by the Group itself.
The success of the Hengdian Group is based on two main strategies:
1) The introduction and development of technology-oriented industries. For instance it established the manufacture of magnetic materials which were exported to Western countries, and the manufacture of building materials which met both local and foreign needs. The Group's principle is that any new investment should be only in high technology industries.
2) The creation of a tourism sector. The Group's decision-makers were well aware of the potential of tourism in the economic development. The natural and cultural environment and its location near Shanghai were good reasons to promote the town's tourism industry. The town was transformed into a small city. Several blocks were constructed in different architectural styles, each reflecting ancient times and cultures such as "Canton town" which recreates Canton of 100 years ago. Together these buildings resemble an open-air museum.
It is interesting to note that the experiences of the Hengdian Group appear to be in conflict with the modern trend for companies to shed social commitments and burdens. For the past decade most state enterprises have complained of too many social burdens. In contrast, the Hengdian Group has never suffered from this problem and even explored new ways of industrialization to solve the social concerns of the community. However, it could be just the tip of the iceberg and there might yet emerge another small "iron bowl" inside the Group when it reaches a certain level of development and management, and local authorities would start to think about how to "delegate social burdens" back to the people.
Until 1992 the main product of the Galanz Group was the feather coat. At that time "Galanz" was the product's brand name and the name of the company was "Guizhou Textile Corporation". Gross output was 180 hundred million yuan (RMB) and export revenue was US$23 hundred million in 1992.
In that same year, the Group's President, Mr. Liang Qingde, after careful market analyses, decided to adjust the product structure. He discovered that the domestic market in microwave ovens was almost entirely monopolized by foreign manufactures, and the ovens themselves had not yet being totally accepted by Chinese families (as had the TV and refrigerator), due to the unique Chinese way of cooking. Gradually, however, the microwave oven penetrated the lives of younger working families in the cities as it saves a lot of time. The Group believing in its potential invested heavily in new technology to compete with Sharp, Panasonic and other famous brands imported from abroad. It was not easy because Sharp and Panasonic have their own joint-ventures in China and had already established themselves in the Chinese market.
In 1994 the Galanz Group introduced its microwave ovens onto the domestic market and it soon became the biggest supplier controlling 25 per cent of the market (see table 4)
Table 4: The main suppliers of microwave ovens in China
| 1995 | 1996 (Jan-June) | |||
| Brand | Sales volume | Market share (%) | Sales volume | Market share (%) |
| Galanz | 31135 | 25.1 | 21202 | 27.1 |
| Panasonic | 23093 | 18.6 | 16470 | 21.1 |
| Sharp | 15961 | 12.9 | 4557 | 5.8 |
Source: Documents offered by Galanz Group
The main competitive advantage of Galanz was low prices for the same quality as their competitors. The price competition for the same quality was the basic marketing strategy of the Group. The average price of a Galanz microwave oven is about 2/3 of that of their competitors. In 1996 its foreign competitors Sharp and Panasonic were forced to reduce their prices due to pressure from Galanz which further enlarged their consumer market. The other Chinese competitors failed altogether.
Two major lessons can be learned from this case. Firstly, the success of the Galanz Group was based on its rich 15-year experience in marketing consumer products on the local markets; and secondly, it invested heavily in high technology and improving the quality of human resources as well as maintaining lower costs of production than their competitors.
Table 5: The growth of the Dynasty Group
| Performance Indicators | 1980 | 1995 |
| Total Amount of Investment (RMB, yuan) | 1376000 | |
| Total Output (Bottle) | 100,000 | 17,000,000 |
| Pre-Tax Profits Per Person (RMB, yuan) | 1,000 | 730,000 |
| Revenue of Products Sales (RMB, yuan) | 200,000,000 | |
| Total Pre-Tax Profits (RMB, yuan) | 120,000,000 | |
| Foreign Exchanges Income from Export (USD, dollar) | 2,000,000 |
Source: Documents offered by Dynasty Group.
The Dynasty Group is a semi-state company with the participation of foreign capital. The management believes that the Group's success is owed to the following three strategies. Firstly, the Chinese own the majority of shares to be able to use their own management methods. In China, most joint-ventures are actually controlled by a foreign partner, both in technology and management. Though they do help Chinese enterprises learn and improve operations and to compete in the market, the lack of decision-making power makes it difficult for the Chinese managers to learn and improve their style and capitalise on their knowledge of Chinese culture. This reduces the enterprises' final effectiveness. The Dynasty Group's experiences proved that Chinese managers could also successfully operate a joint-venture. Until now there is only one foreign vice-general manager (from France) in the Group. The Chinese/French share allocation has been 62 per cent and 38 per cent respectively for the last 16 years.
The second strategy was to create their own famous brand name "Dynasty" and produce high quality wines in China. Usually, joint-ventures would take advantage of their foreign partners by using their established brand names and thus making it easier to promote sales through foreign distribution channels and save expenses on advertisement. However, the Dynasty Group's first priority was to develop its own Chinese brand name and to change the Chinese people's taste in wine, as traditionally Chinese wine is very sweet. After 16 years the Dynasty Group successfully managed to introduce a totally different wine which was delicious and of high quality. They also produced a low-priced table wine to meet the demands of the common consumers. Today, more and more Chinese prefer to drink "Dynasty". Once this priority was successfully achieved, the third strategy was to promote a series of products for different market niches - from luxury to average wines. There is huge potential for moderately-priced wine. In 1995 a new agreement was signed between the Chinese and French investors to extend their partnership in the Dynasty Group for another 100 years. The "Dynasty" brand has also been recognized abroad.
Joint-venture is an important instrument in promoting state enterprise reform, and this experience of the Dynasty Group could be valuable to other enterprises. There is no doubt that joint-ventures have played an important role in China's economic development. However, some politicians in the central Government are in doubt as to whether restructuring directions and policies might be out of the Chinese people's control one day. Perhaps the experiences of the Dynasty Group could offer a positive answer to this question.
The local Government reached its goal in enterprise restructuring within 4 years. Revenue increased from 31.7 million yuan (RMB, 1978) to 2.6 hundred million yuan (RMB, 1995), and GDP from 4 hundred million yuan (RMB, 1978) to 70 hundred million yuan (RMB, 1995). Infrastructure greatly improved due to the increase in investment by the local Government. The basic industrial structure was under total reconstruction and by 1994 Zhusheng was listed as one of the 100 richest counties in China.
Prior to 1996, Star Insulation Materials Company was a small state enterprise with 182 employees and was called Zhucheng Insulation Materials Factory. Its main products were insulation materials with a production of 530 tons per year. By 1992 the factory was losing money (see tables 6 and 7).
Table 6: Company economic indicators (RMB yuan)
| YEAR | 1990 | 1991 | 1992 |
| Revenue from sales | 3,886,000 | 5,594,000 | 8,007,000 |
| Cost, tax and other expenses | 3,158,000 | 5,181,000 | 7,441,000 |
| Total pre-tax profits | 302,000 | 361,000 | 492,000 |
| Total after-tax profits | 27,000 | 17,000 | 1,000 |
Source: Documents offered by Star Insulation Material Company
Table 7: Property and liabilities indicators (RMB yuan)
| YEAR | 1990 | 1991 | 1992 |
| Total assets | 4,784,000 | 6,597,000 | 10,000,000 |
| Total liabilities | 2,809,000 | 4,168,000 | 7,132,000 |
| Net value of assets | 1,975,000 | 2,429,000 | 2,870,000 |
Source: Documents offered by Star Insulation Material Company
In 1993, the Government of Zhucheng carried out a series of policies to restructure the property rights of 37 state enterprises. Zhucheng Insulation Materials Factory was one of them and it was renamed Star Insulation Materials Company. The restructuring process in this company aimed at:
To achieve these objectives total assets and liabilities were restructured into registered shares which were sold to the company employees upon reevaluation. Total renewed registered capital amounted to 180 million yuan (RMB) and capital per share was 1000 yuan (RMB). Preferential policies and company regulations by the local Government could be summarized as follows:
- from second year: 33 per cent (normal);
The renewed Star Insulation Materials Company finished restructuring its property rights by June 1st, 1993. All employees were asked to buy at least 10 shares in order to become shareholders and the 1800 shares were almost equally distributed among them. In fact only a few employees refused to buy shares or were not willing to buy more than 10 each. Some did not want to buy as they did not have enough money or were not confident about the future of the company. Others, on the other hand, volunteered to buy shares because they were afraid of losing their jobs.
Only small changes took place in the leadership and organizational structure of the company. For example, the old factory director changed his status to become chairman of the new board of directors and general manager. Employees were encouraged to put more effort into their performance although the system was not participative. The only incentive was that everyone cared about their own money as shareholders and the general manager had decided to raise the rate of dividends to 20 per cent or above if they worked hard. This figure was actually exceeded in 1994 due to good performance (see table 8). Today Star Insulation Materials Company has entered into the ranks of the 30 biggest insulation materials manufactures in China. In 1996 only four enterprises among the 30 were profitable - Star Insulation Materials Company being one of them.
Table 8: Economic indicators, 1994 (RMB yuan)
| Revenue from sales | 28,040,000 | Total pre-tax profits | 5,800,000 |
| Average salary of workers | 6,230 | Total after-tax profits | 3,300,000 |
| Dividend for shareholders | 23.4% | Total share capital | 3,800,000 |
Source: Documents offered by Star Insulation Material Company
3.4 Conclusion
The above case studies indicate a very important role played by the non-state sector in the Chinese economic development since 1978. China's growth rate of GDP has remained very high, particularly from 1992 to 1995 when there was a 2-digit growth rate. This is mainly the result of rapid growth of non-state enterprises. Despite these achievements there have also been some important problems with the development of the non-state sector:
1. Most non-state enterprises are still at a low stage of development with an under-trained labour force. Their managers do not have enough experience to build up sophisticated technologically-modern enterprises. The business environment still encourages non-state enterprises to operate along the same lines as state-owned enterprises because of too much central and local government intervention.
2. In most cases the development of private enterprises depends less on sound organization, than on a competent manager, usually the founder of the enterprise. As a result, the management style and organizational culture are often autocratic. It is difficult to maintain continuity if the company leadership or business environment changes.
3. Most non-state enterprises were set up in the relatively undeveloped coastal regions. They consider their own growth as top priority, sometimes even at the expense of the environment. The waste of natural resources and heavy pollution are becoming very serious and are expected to worsen in the future if urgent measures are not taken by government.
4. Labour relations are based mainly on emotional ties and less on legal regulations. The role of trade unions in non-state enterprises is weak compared with state enterprises and worker protection measures are more difficult to implement. To correct this, the All China Federation of Trade Unions (ACFTU) has requested every joint-venture and township enterprise to set up a trade union to look after workers' rights.
Taking in consideration the successes and problems in enterprise restructuring described above, the following conclusions could be drawn:
In summary, before China's economic reform all enterprises belonged to the public sector. Non-state enterprises only appeared in the early 1980s. Those earlier non-state enterprises were still affected by traditional management styles and culture.
As the market economy developed, managers of non-state enterprises soon become aware that they must change their approach to match competition. This new kind of management could be described as a "dumbbell". The feature of a dumbbell is small in the middle and large at both ends. At one end, production should be increased based on market research and R&D; and at the other end, sales promotion and after-sales services should be expanded.
Without emphasizing these two ends, an enterprise and its products would lose competitiveness in the market. These two "ends" should be placed at a focal point; "small in the middle" means the enterprise should fully utilize cooperation, networking and alliances with other companies producing specialized parts and components for its products. The traditional way under the planned economy was that the enterprise should produce everything itself. Their motto was "do not ask others". This was actually based on the agricultural, self-sufficient economy which reduced industrial and technological specialization. It was, and still is, a great waste of investment and other resources.
Under the new expanding market economy, it became important to develop specialization and encourage cooperation among enterprises and to develop strategic alliances. So the "dumbbell" is the only way to improve competitiveness. The transformation of management to the "dumbbell" method is a long-term objective for the transition economy, but it is well suited to the Chinese traditional business culture - building-up entrepreneurial networking.
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