Russian Privatization and Corporate Governance: What Went Wrong?
Black, Bernard, Kraakman, Reinier, Tarassova, Anna, Stanford Law Review
Rapid mass privatization of state-owned enterprises in formerly centrally planned economies hasn't turned out the way its creators hoped, in Russia or elsewhere. When Russian mass privatization began in the early 1990s, its proponents (including ourselves) hoped that the Russian economy would soon bottom out and then turn upward, as the efficiency incentives unleashed by privatization took hold.(1) That didn't happen.
Russia's mass privatization "voucher auctions" were moderately honest, but gave control to managers. This permitted insiders (managers and controlling shareholders) to engage in extensive self-dealing (transactions between insiders and the company, in which the insiders profit at the company's expense), which the government did nothing to control. Later privatization "auctions" were a giveaway of Russia's most important companies at bargain prices to a few well-connected "kleptocrats," who got the funds to buy these companies by skimming from the government and transferred their skimming talents to the enterprises they acquired.
At the macro level, the Russian economy stumbled along through mid-1998, then collapsed again, as it had in 1991-92 prior to privatization. Russia's medium-term prospects are only so-so. The Russian ruble has plunged; the Russian government has defaulted on both its dollar- and ruble-denominated debt, most banks are bankrupt, corruption is rampant, tax collection is abysmal, capital flight is pervasive, and new investment is scarce. The Russian economy rebounded somewhat in 1999 and 2000, but from a greatly shrunken base and mostly because oil prices soared. The fundamentals of nonextractive industries haven't changed that much. It remains to be seen whether Russia's new President, Vladimir Putin, will develop a coherent economic policy--none has emerged in his first year as Prime Minister and then President.
Russia's disappointment with mass privatization is mirrored in other former Soviet Union countries and, less severely, in the Czech Republic, which at one time seemed to be a model of the transition from central planning to a market economy. This suggests that the failure of privatization to jumpstart the Russian economy may reflect structural flaws in mass privatization as a transition mechanism, not just Russia's specific circumstances.
This article joins an emerging literature that questions whether rapid mass privatization of large firms is an important element of the transition from central planning to a market economy.(2) We develop below a case study of what went wrong with large-firm privatization in Russia, using the Czech Republic as a comparison case study to assess the extent to which Russia's problems are generalizable. We bring to this task a reasonable mix of insiders' knowledge and outsiders' skepticism, gained through experience with privatization and capital markets reform in Russia and other countries.(3)
We leave to others the analysis of the macroeconomic steps that Russia might have taken and focus on microeconomic steps related to privatization and capital markets development. But the two are related. Russia's macro effort to balance the budget, control inflation, and attract investment was defeated, in large measure, by the micro failures we discuss below.
We see three main failures in the Russian privatization effort. First, mass privatization of large enterprises is likely to lead to massive insider self-dealing unless (implausibly in the initial transition from central planning to markets) a country has a good infrastructure for controlling self-dealing. The critical factor is lack of controls on self-dealing, and not the details of the privatization plan. If control is given to the current managers, as in Russian mass privatization, they often won't know how to run a company in a market economy. Some managers will loot their companies, perhaps killing an otherwise viable company. …