1. The Impact of Privatization in Post-Communist Countries Presented by Saul Estrin Department of Management 13 th April 2007

2. Outline of Presentation  The Issues  Policies, Institutions and Privatization  Sequencing of Privatization  Privatization of Growth  Privatization and Company Performance  Conclusions

3. Objective  To evaluate the economic effects of privatization, focusing on experiences in post communist countries and China  Transition economies as a laboratory of systemic change

4. Findings  Privatization to foreign owners raises efficiency; less clearcut in China because domestic ownership also raises TFP  Domestic private ownership raises TFP, but less than foreign ownership, in CEE and Ukraine but not in Russia

5. Findings  Ownership concentration important  Worker ownership does not have negative effect on performance  New firms more efficient than existing ones, especially foreign start-ups

6. Policies, Institutions and Privatization  Megginson and Netter (2001) show privatization improved company efficiency and profitability in developed and middle income economies  Privatization seen as pivotal, even defining, in transition process

7. What Were the Reasons for Privatization?  Problems of corporate governance in state owned firms (SOEs)  market for corporate control and capital markets  ownership concentration  outsider ownership  soft budget constraints

8. Policies in Transition Economies  Type 1 Reforms - Stabilization, price liberalization, privatization, social safety net  Type 2 Reforms – development and enforcement of laws, regulations and institutions conducive to market economy

9. Policies in Transition Economies  Type 2 reforms easier in EU Accession countries  Everywhere progress relatively slow and modest

12. Privatization Methods  Need for fast privatization because:  Price reforms not enough to improve efficiency of SOEs  State likely to continue to meddle in SOEs  Managers would decapitalise SOEs  Political need to forestall return of communists  But how to privatize thousands of firms while ensuring equity and political viability. Led to “mass privatization”

13. Privatization Methods  Serious concerns about the quality of privatization (ie retained state ownership, long agency chains, insider ownership) and whether privatzation had taken place before the relevent legal and institutional framework were put into place.

15. Sequencing of Privatization  Govenments sequence privatization because:  Avoid transaction and congestion costs  Reveal information about firms to buyers  Avoid opposition (“gradualism”!)  Avoid unemployment

16. Which Firms Do They Privatize First? Gupta,Ham, Svejnar,2000  Firms that are more profitable  Firms with higher market shares  Firms in industries subject to greater demand uncertainty and in downstream industries (needing flexible management) Important implications for reverse causality

17. Which Firms Do They Privatize First?  Firms in industries subject to greater demand uncertainty and in downstream industries (needing flexible management)  Important implications for reverse causality

18. Privatization and Growth  Plane 1997 on developed economies: privatization has stronger positive effect on growth when it occurs in infrastructure and industry  Zinnes, Eilat and Sachs, 2001: privatization increases GDP growth when accompanied by institutional reform

19. Bennett, Estrin and Urga, 2007  Sample of 26 transition countries, 1991- 2003. Panel data and GMM methods with fixed effects  GDP growth associated with investment in physical and human capital, private sector and capital market development and privatization method

20. Bennett, Estrin and Urga, 2007  Countries which predominatly used mass privatization methods enjoyed significantly higher growth post- privatization compared to those that used other methods  Growth not associated with private sector or capital market development

21. Privatization and Company Performance  Foreign Direct Investors  Strategic Owners  Entrepreneurs

22. Methodological Issues  Previous studies indicate astonishing variation in findings, from strong positive to strong negative effects of privatization

23. Methodological Issues  Reasons partly methodological: early studies used small/unrepresentative samples, unable to control for selection/endogenity, and data peiod too short  We use all available studies (150 plus) and categorise by quality of estimation method and sample size

24. Overview of Approach  Three categories of paper (C1-3); focus on C1 ( large samples, control for selection) papers  Large variety of performance measures (TFP, labour productivity, profitability, financial performance, sales, employment, wages)

25. Overview of Approach  Look at studies in CEE, CIS and China  Focus on TFP and profitability results

26. Foreign Direct Investors in Transition Economies  9 C1 studies of TFP (out of 21); 4 C1 studies of profitability ( out of 13). All post 1998  all show privatization to foreign owners increase TFP or profitability

27. Foreign Direct Investors in Transition Economies  Holds in countries with both weaker and stronger institutions e.g Hungary, Czech republic, Poland, Russia and Ukraine  Example: Brown Earle and Telegdy, 2006 (TFP), Claessens and Djankov, 1999 (profitability)

28. Foreign Direct Investors in China  5 studies, best three are C2  Positive significant effect of foreign ownership on TFP ( Hu, Song, Zhang, 2005)

29. Domestic Owners in Transition Economies  Domestic private ownership raises TFP but the effect is quantitatively smaller than for foreign ownership  Reasons for previous ambiguity in literature is failure to take account of selection effects

30. Domestic Owners in Transition Economies  TFP effect positive in CEE but negative in Russia (Brown, Earle, Telegdy); suggests institutional quality important  7 studies look at insider ownership; effects insignificant in 6 and positive in one  Two of the three C1 studies find the effects on profitability to be positive

31. Domestic Owners in China  No C1 Studies yet!  Results mixed but generally weakly positive for TFP and profitability

32. Domestic Owners in China  Possible explanation: Tian and Estrin, 2007, find that impact of private ownership is U-shaped. Initially ROA decreases as private ownership increases, and then rises. Explain by concentration of state ownership and benefits dominant state ownership can bring in China

33. Entreprenerial Ownership  Sabirinova et al, 2005 find foreign start ups less efficient than existing foreign owned firms, more efficient than domestic start-ups, which are more efficient than existing domestic firms

34. Entreprenerial Ownership  Commander and Svejnar, 2007,find domestic start-ups less efficient than foreign owned firms but not different from domestic or state owned firms.

35. Conclusions  Clear picture is emerging from methodologically sound studies on transitions economies.  Despite reservations about the methods at the time, privatization not a failure when considered more than ten years hence

36. Conclusions 1  Privatization to foreign owners clearly raises performance relative to state ownership, and to domestic private ownership  Privatization to new domestic owners also raises performance if institutions are better developed, ie CEE and China relative to Russia

37. Conclusions 2  Reasons for Superior Performance of Foreign Owned Firms  Limited skills and access to world markets of domestic owners and managers  Domestic ownership sometimes associated with looting, tunnelling, defrauding minority shareholders, reducing performance  Privatization process prevented domestic ownership concentration initially; it took time to squeeze out dispersed shareholders.

38. Conclusions 3  Results highlight importance of good management and corporate governance, access to world markets, prescence of functioning legal and institutional system for company performance  Foreign firms bring in expatriate managers and train local ones

39. Conclusions 4  Their corporate governance compensates for underdeveloped local institutions, laws and norms  They bring access to global distribution networks.  Domestic owners can achive the same in time, and are increasingly doing so however.