Major guide to an unknown journey

In 1989 East European Communism gave a last gasp and collapsed, and the complex process of transition to some species of market economy was started.

The Polish pioneers of the transition noted that there was no guide book which mapped the route from socialism to capitalism, although much had been written about the journey in the opposite direction. Guide or no, immediate problems had to be dealt with and the most pressing was how to bring runaway inflation under control.

Caravans of Western advisers travelled to the region and soon the economic problems of transition were conveniently pigeon-holed in boxes labelledstabilisation, privatisation and restructuring.

Stabilisation, it was almost universally agreed, was the pressing concern. Most policy advisers argued for speed and suggested that "shock therapy" might do the trick. A few however, with socio-political considerations in mind, urged caution and recommended "gradualism".

"Shock" versus "gradualism" dominated discussion over the first phase of the transition period. But it also became plain that no matter which was applied, economies would respond in diverse and often unexpected ways.

As the complexities became clearer and as the problem of inflation abated, so attention shifted from stabilisation to items further down the agenda -- to privatisation and restructuring. It became clear that privatisation --in one sense the simple transfer of ownership rights -- was by no means as straightforward as had been thought. In late 1989 the Polish "office for ownership transformations", the precursor of the ministry of privatisation, boldly proclaimed its intention of privatising 50 per cent of state assets within three years. Yet a year later, as 1990 drew to a close, the Polish authorities still struggled with the privatisation of the first five (out of about 7,000) state companies.

Of course some difficulties, such as the shortage of domestic savings, were anticipated. Others, the valuation of assets, were plainly underestimated, while some problems, most notably the notion of legal title to assets, were shrouded in a misty ambiguity that frequently still confounds attempts to spotlight ownership.

But in the face of difficulties came new solutions, engineered but also heavily influenced by the inheritance of central planning and, more important, by the economic reforms of the 1960s and 1970s. This means of course that new approaches to privatisation are conditioned by local circumstances and a much richer range of privatisation models now exists than in 1990. The Czechoslovak and Russian voucher schemes were implemented quickly and differ greatly from the Polish model of mass privatisation, while in Hungary strong managerial interests meant that privatisation proceeded relatively slowly.

The great value of this volume by Roman Frydman and Andrzej Rapaczynski is that it not only describes but also helps us understand this evolution. Starting from the fundamental question "why privatise?" the authors explain that product market competition with its ultimate sanction of bankruptcy is not enough to ensure best use of resources. In fact it is positively dangerous to assume that competition in the market place is enough, since inefficient management in charge of efficient enterprises can do much damage.

Privatisation, the authors argue, should not be viewed as the last brick in the construction of capitalism but as a crucial element ensuring that resources are well allocated. It is needed for the "efficient control of management performance"; it is a "complex social and economic transformation" designed to change the manner of business decision-making.

This book sets out a general theoretical framework which throws the central issues of privatisation into clear and sharp relief. It draws heavily on the Polish experience but manages to avoid the narrow recounting of legislative detail that obscures fundamental issues.

What are the major issues for Frydman and Rapaczynski? The most important is the question of corporate governance: how to privatise in a manner which creates effective owners able to restructure firms. This, it has turned out, is very much more difficult than might be assumed. First, it is difficult to know in East European conditions which are the viable and the non-viable firms. Privatising the non-viable invites disaster especially since the state may then come under a strong (private) interest group pressure -- a new lobby -- to obtain subsidy. Second, the transfer of either ownership or control is no simple matter and this, in good part, is because insiders, workers and managers, powerful but sometimes under-researched groups, may have effective control, if not legal title over enterprise assets.

One great merit of this book is the careful attention devoted to the insider in a general theoretical perspective which identifies the collapse of central planning as opening a "control gap" in the firm. The pressing question is then how to fill this gap? If not the state then who? New private owners of course provide one answer but the insiders also have a powerful influence that can thwart the privatisation process itself. And what should the process be? Individual sales, the British model adopted in Poland, were an unfortunate distraction. Stumbling over obstacles such as assets valuation and lack of savings, they could never provide the fast track that privatisation needs. This leaves free distribution as the only way forward: then the crucial question is how to design mechanisms that also provide genuine control and restructuring possibilities?

There is another aspect of privatisation that needs to be considered: alongside privatisation must go the rundown by the state of non-viable state enterprise. The very big question that remains unanswered is how to manage this rundown while avoiding the political turmoil that could threaten to halt the entire privatisation effort. And there is a conundrum here: if the non-viable sector is not run down, it is hard to see how the private and privatised sectors will be able to develop vigorously since they will provide the tax base for the support of the state sector. Frydman and Rapaczynski again perform a valuable service by setting out very clearly, in their final chapter, what is at stake.

For some time the centre of gravity in the economics of transition literature has been tipping away from macro-issues to those deeply ingrained, but in many respects much more intractable, micro-concerns -- ie enterprise behaviour -- which were overlooked when alarm over inflationary prospects dominated all else. Privatisation in Eastern Europe sets out, for the first time in book form, a broad theoretical framework, locating privatisation in terms of the well known compass points of corporate governance and principal-agent behaviour. It is a major contribution to our understanding not only of privatisation but of the organism that is the state enterprise in Eastern Europe today.

George Blazyca is associate head of the department of economics and management, University of Paisley.