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East: Privatization Determines Countries' Economic Success

Washington, 11 June 1997 (RFE/RL) - Privatization has been the "single most important determinant of success" in industrial restructuring in the nations of Central and Eastern Europe, according to a new study by four World Bank economists.

Even more, the study found that rapid privatization increased productivity three to five times, sped the general process of restructuring in the country, and was "the most important factor" in the solvency of the banking sector.

World Bank economists Gerhard Pohl, Simeon Djankov, Stijn Claessens and Robert Anderson, analyzed over 6,000 industrial firms in seven countries -- Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovak Republic and Slovenia -- from 1992 through 1995. They said these countries had adopted different policies to encourage industrial restructuring, thus providing a good source of data on what works and what doesn't.

Using a definition of a privatized firm as one that has more than 33 percent of its shares in the hands of private investors -- but excluding utilities, banking and agriculture -- the authors said privatization accounted for almost "all productivity growth" since the start of reforms.

Labor productivity in the region grew at an average rate of 7.2 percent per year for privatized firms, but declined by 0.3 percent for state-owned enterprises.

Bulgaria, with "insignificant" privatization, had a productivity decline of 1.4 percent in the three years 1992-1995. At the opposite extreme, the Czech Republic, which had privatized 89 percent of its manufacturing firms by the end of 1995, recorded an overall productivity rise of 6.8 percent.

Importantly for the health of the general economies, the study found that privatized firms reinvested a portion of productivity gains back into the business and did not immediately return all of it to workers in higher wages. As a result, the study said, the businesses grew better and workers in privatized firms wound up with a more rapid growth in real wages in the long run.

By contrast, it says, government-owned firms tended to raise wages beyond any labor productivity gains, thus eroding internally generated financing and further cutting output.

For the country as a whole, this meant that the effects of privatization on wage restraint -- an important ingredient in fighting inflation -- was far more important than government wage policies.

So even in the Slovak Republic, which imposed "vigorous wage restraint in the state sector," real wages still outstripped productivity, in contrast to the private sector.

Interestingly, the study found that the form of privatization had little to do with its ultimate success. Despite early fears that such forms as mass privatization or management-employee buy-outs would not help restructuring, the study found "only minor differences."

A far stronger effect in speeding transformation -- and profitability -- was the extent to which a firm's stock was concentrated in the hands of a few institutional or strategic investors. When the stock is spread too thinly, there is no single group of investors able to exert influence on the firm's management. However, when a small professional group such as investment funds and banks control a majority of the shares, they are able to monitor management performance and force even greater reforms.

The most intriguing finding of the study was that rapid privatization was the most important determinant of the solvency and stability of banks in transition economies.

Many banks in the region inherited large non-performing loans when their state enterprise customers were suddenly exposed to competition and started to have large operating losses. Audits done by international standards showed that up to 60 percent of the banks' loan portfolios were worthless, and international experts advised these nation's to absorb the bad loans.

That was "premature," says the study, because in countries which implemented large privatization programs, the privatized firms improved their profitability so much more than expected that government intervention was redundant.

On the other hand, it says, in countries with little or no privatization, the financial condition of firms did not improve and bad loan problems for banks were even "worse than the pessimists expected."

The study was released as a technical paper by the World Bank, which means the views are not necessarily those of the bank.