Privatization in Eastern Europe: The Tunnel at the End of the Light

I n the former Soviet empire, the collapse of Communism created an opportunity for the victims of one failed utopian ideology to find another. The evaporating Soviet system left an ideological vacuum that was quickly filled as legions of Western advisers arrived to help translate the goals of political democracy and a market economy into an action agenda: "democracy" translated quickly into elections; a "market economy" into privatization.

As in many hurried translations, the bare essentials were grasped, but much was missed. Elections are essential to democracy, but functioning democracies are built on much more than just elections. And private ownership is only one element of a modern market economy. But it was fundamentalist capitalism that poured in--the simple, universal program that all could understand: free prices, free trade, and, above all, privatize.

The fate of small enterprises like shops, restaurants, or farms was never at issue. Everyone agreed that rapid small-scale privatization was the best way to energize private sector growth and to develop a capitalist ethic and an entrepreneurial class.

The thornier question was how, and how fast, to privatize the clunking state enterprises that employed thousands and thousands. Supposedly, only an abrupt and ruthless privatization could clear the stage of the remnants of a command economy--the perverse incentives, the incompetent and corrupt apparatchiks, the endless subsidies, the mindless production of the wrong goods. Delay risked permitting those who stood to lose the most from privatization--the old-line bureaucrats and the managers and workers of the giant state enterprises--to undermine the privatization process, thereby jeopardizing the transition to a market economy. According to Harvard University economist Jeffrey Sachs:

The need to accelerate privatization in Eastern Europe is the paramount economic policy issue facing the region. If there is no breakthrough in privatization in large enterprises in the near future, the entire process could be stalled for political and social reasons for years to come, with dire consequences for the reforming economies of the region.

The Economist agreed, calling "the growing acceptance of...gradualism...the greatest peril now facing the countries of Eastern Europe."

But there is an alternative to radical privatization, and it is not just a smokescreen put forward by nostalgics for the old system. It is rather the safest and sanest approach to building a market economy and democratic society.

Rapid privatization will backfire, for few of the newly privatized big companies can survive in a competitive market environment. The structures of both supply and demand for these giant firms have been shattered; the industrial linkages among Eastern Europe and the former Soviet republics are severed. The abrupt political change separated enterprises from their traditional customers the way the movement of rivers into new channels left medieval entrepots high and dry on silted streams. The economic collapse resulting from sudden privatization would result in extensive layoffs, massive bankruptcies, and social unrest. In a climate of chaos, the state would eventually have to support the failing enterprises, one way or another.

Markets can't regulate monopolies. A heritage of monopolies implies active regulation. Who shall regulate monopoly and oligopoly industries? Who shall oversee the liquidation of the losers, the temporary subsidy of restructurings, and the re-employment of workers? For a prolonged period, newly privatized firms won't be able to compete in their home markets against superior imported goods. Who shall oversee international trade and ration foreign exchange, as West European governments had to do after World War II? Further, such essential preconditions for modern capitalist economies as an established legal system or tax code, financial institutions, and effective capital markets do not exist. These shortcomings increase the odds that a "big bang" privatization will turn into a "big bust."

This essay develops the argument for a pragmatic approach to privatization. It boils down to three basic contentions.

First, the creation of capitalist institutions takes time. Privatizing ownership will not by itself make large, uncompetitive enterprises operate efficiently. Nor will distributing ownership of shares create a market system or a capitalist culture. Giant corporations need internal capabilities in organization, pricing, labor relations, accounting, and marketing in addition to productive incentives. The repair of severed domestic and international linkages--among existing plants, between suppliers and users, between firms and their traditional markets--will also take time.

Second, private ownership, even in the Western context, makes sense only in the context of embedded socioeconomic institutions. Big companies don't exist in an institutional vacuum. Nor do markets. Both require external structures of law, finance, and regulation. Erecting a system of domestic finance with efficient capital markets is but one important example of such needed institutions.

Third, the state will inevitably play the major role in industrial development in most of the countries of the former Soviet empire, especially Russia, for a long interim. It will help create and regulate markets; it will control imports and oversee the flow of capital; and, irrespective of the chosen privatization strategy, it will effectively control substantial portions of major industrial assets. The competitive vulnerability of existing industry allows no other alternative for the near future. The creation of an honest and effective public administration--not the broad distribution of shares in uncompetitive giant firms--is the key step toward the creation of a successful capitalistic market system and a functioning democracy.


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VARIETIES OF CAPITALISM, OR WHO OWNS MITSUBISHI?

Radical capitalists ignore the great differences in the institutions of private ownership of big firms in such successful capitalist countries as the U.S., Japan, Germany, France, and Italy, as well as the other enormous institutional differences that distinguish the competing capitalisms. They strip away the complex variety and reduce private ownership to the simple model of textbook economics. They neglect history, they discard experience. Any remotely appropriate historical experience--such as Europe after World Wars I and II--points in a quite different direction.

Radical capitalists insist that only a system of privately owned firms linked together by markets provides the right incentives and the right constraints, a set of signals that promotes social dynamism and optimal allocation. Moreover, market signals are prompt and unrelenting. Adaptation is fast and permanent. One of the impressive aesthetics of capitalism is the perfect match between efficiency in capital formation and efficiency in production. Moreover, newly privatized industries are likely to attract foreign investors--the main sources of modern technology and management skills--more readily than state counterparts. Finally, competition will relentlessly downsize the old industrial monsters into more productively sized companies.

At first glance, the radical capitalist argument is appealing. The problem, of course, is that the textbook caricatures of the institutions of modern capitalism obscures an understanding of how the different systems actually function. Take the two critical institutions--price-driven, "free" capital markets and private ownership of giant corporations. Neither is simple in practice; and neither is universal in form.

In France, as in Japan, Germany, and Korea, for more than a generation after World War II, capital markets were neither "free" nor price-driven. To a critical extent, especially where giant corporations were concerned, capital was allocated less by price (as in the proposed capital markets for Eastern Europe) than by administrative systems of priorities.

Nor does the pragmatic experience of forms of ownership correspond to the simplistic radical capitalist model. In Japan, the most successful case ever of rapid development, ownership is "private," but only if one defines private as not owned by the state. Interlocking shareholding and finance within the industrial groups known as keiretsu created something far removed from the simple ownership model of the radical capitalists. Keiretsu have no obvious analogy in the rest of the First World, and no place whatsoever in Econ 101 textbooks. Who owns Mitsubishi? Perhaps the most accurate functional answer is "Mitsubishi owns Mitsubishi."

The form of ownership is an important element in modern capitalism, but it is less a unifying than a differentiating characteristic; and it takes its real world meaning only within the complex institutional context that defines a particular capitalist system. There is more than one variety of successful capitalism.


STRUCTURAL CONSTRAINTS AND REALISTIC CHOICES

Just as it is dangerous to apply narrowly naive concepts of capitalist institutions to the different countries of the former Soviet realm, so it is dangerous to generalize about this region. The several countries have different political systems, legal traditions, ownership patterns, educational levels, industrial structures, languages, ethnic cleavages, religions, and, of course, sizes. It is little wonder that of the countries most actively engaged in privatization--the Czech Republic, Slovakia, Poland, Hungary, Slovenia, and Russia--each has a different privatization strategy. Nonetheless, the Communist system left a shared legacy that constrains the prospects for rapid privatization. At least seven of these troubling legacies will shape the results of privatization.

1. Shortage of entrepreneurial experience; surplus of criminal experience. More than 40 years of Communismhave produced a managerial class ill-equipped to function in a capitalist market. The best of the technical-managerial leadership is lodged in the military-industrial complex, a declining market. Most of the market experience comes from the "second economy," and it is dubious that such experience will translate into competent large company ownership or management.

Besides petty black marketeers, the other likely new ownership stratum is those who made money illegally--big-time black marketeers or corrupt bureaucrats--or both working together, as they always have. They are best positioned to cash in on abrupt privatizations. They can split enterprises into valuable and potentially negative parts, shift labor across those parts, maintain control of the good bits, and reap a capital gain at the moment of privatization--millionaires in one quick shot. They can reap a windfall gain no matter how the enterprise performs. Even where assets are auctioned to the highest bidder, these networks of officials and plant managers, with their underground allies (most often called, locally, "the Mafia"), typically have the cash and insider knowledge to bid. This potential was not lost on sophisticated foreign advisers: bars in foreigners-only hotels are filled with International Monetary Fund and World Bank officials explaining how the late medieval capitalists in Europe were considered, in their time, to be criminal elements. Likewise, the winners of the American bootlegging wars have now become solid, corporate capitalists. Privatization ideally would transform the criminal mafia into normal organizations--unless, of course, the Southern Italian model were to prevail.

2. Shortage of companies ready for a market economy. Most of the giant enterprises are burdened with obsolete product and process technology and mountains of debt. The debt will be written off by the state one way or another. But even with newly cleaned balance sheets, they are poor candidates for market viability. Finding real private owners to run them, without permanent subsidy and protection, will be difficult. Even the German privatization agency the Treuhandanstalt, despite an infusion of about $100 billion, had only privatized about half of the eastern German industries by 1992, representing the best of Communist enterprise. Some 1.6 million workers remain under Treuhand jurisdiction. Despite its ferocious determination to the contrary, it would not be surprising if the Treuhand found itself slowly transformed into a new German version of Italy's much maligned I.R.I. (the giant state holding company).

3. Poor work habits. This report from the New York Times is typical: "Managers of new private companies say they must dismiss dozens of people to find one not afflicted by the lackadaisical work ethic fostered by the Communist system. Private hotels in Warsaw do not even accept applications from former state employees."In addition, a hierarchical mentality still pervades enterprises. In the past, incentive structures in Communist enterprises discouraged managers from acting with initiative. In most cases, managers were better off playing along with the system than risking their position by exercising discretion.

4. Shortage of domestic and international capital. The previous regimes left the economies virtually without savings. The rebuilding of the industrial capacity in the region cannot rely on small contributions from the accumulated savings of the domestic population. Newly privatized firms will need debt financing from domestic banks or from institutions based abroad. Yet none of the governments has yet established a banking system ready to make the loans. Moreover, real and/or nominal rates are high, and credit is generally very tight throughout the region. The major source of capital is likely to remain the state, or in very selected circumstances, foreigners.

The newly privatized firms, striving to become competitive, will not be the only large claimants on the small capital pool. Indeed, they will most likely find themselves at the end of the queue. The best candidates for privatization, and for capital infusions, are the classic infrastructural industries: telecommunications, road building, railways, airlines, and the like, not to mention electric power generation--the handling of those dangerous nuclear power plants on West Europe's doorstep. The Western Europeans want those stations rebuilt for safety, and their nuclear power industry is hurting from a lack of orders. They will provide massive investment to the newly privatizing electric utilities, thus combining safety and capitalist development in the East along with safety and the generation of business for state-supported industry in the West.

Privatizing infrastructural industries would also have the advantage of producing tradable shares with which to generate capital markets. Moreover, they would be acceptable vehicles for international aid and investment institutions that are obligated to make a substantial portion of their financing to private firms. All in all, such industries present an ideal set of financeable and potentially privatizeable activities, protected from the vicissitudes of markets and competition. They are not, however, very likely, to be particularly generative of a new capitalist culture.

Those who expect a major capital injection from the West are likely to be disappointed. A "Marshall Plan" for the former Soviet empire is not in the cards. For one thing, recession and high government deficits have drained public coffers in the West. For another, there are alternative targets for scarce Western and Japanese capital, in Asia and Latin America. To date, inbound private investment has been quite small. For instance, in 1990 and 1991, Poland received $1.3 billion, Czechoslovakia $800 million, and Hungary $2.3 billion. World Bank commitments to the region for 1991 amounted only to a little over $3 billion. The EBRD (European Bank for Reconstruction and Development) put in only about $800 million, about half for telecommunications loans. Over the same period, as noted, East Germany, a territory of some 17 million souls, received almost $100 billion. Multiply that amount by ten to get a comparable infusion for Russia alone, and one can see that the German experience, a new intra-German Marshall Plan, is not a model for the region. Finally, there will be dramatic differences among the host nations in the role of foreign capital. Foreign capital and foreign markets will be major shapers of the Czech economy; they will necessarily have only a small impact on the Russian economy.

5. Risky business conditions. Marko Simonetti, director of privatization for Slovenia, argues that the challenge of privatization is to find active owners willing to lead companies through the transition period. But why should new owners restructure their enterprises when there may be an immediate payoff if they simply liquidate the assets? Domestic producers won't be able to compete effectively in open markets, at home or through exports. A quick taste of what lies ahead is the case of large state enterprises in eastern Germany. Unable to compete abroad, these firms lost their home market when products and companies from the western part of the country moved in.

The temptation to liquidate rather than to invest is heightened by the asset value of many companies. The company's land, buildings, and the right to do business may be worth more in the marketplace than its productive potential, lying in often dubious and difficult assets like machinery or the labor force. A common story is that of CKD Tatra--until recently the world's largest maker of tram cars, but last year the manufacturer of only 300--which has attracted investment interest mostly because its factory sits on valuable land in central Prague. This is simple rent-seeking, not entrepreneurship.

6. Weak links between labor, suppliers, manufacturers, and consumers. First World countries like Japan and Germany were able to get back on their feet quickly after World War II partly because reconstruction meant the reconstitution of forms of economic organization established years earlier rather than the creation of completely new relationships. For instance, keiretsu, the centralized forms of ownership in Japan, were antedated by zaibatsu which originated a century ago in the Meiji era. German business and unions reached durable working arrangements long before the postwar German miracle. Eastern Europe won't be able to manufacture those relationships overnight.

7. Fragmented markets; broken international linkages; ethnic hostility. The countries emerging from the former Soviet empire are fractured by unresolved differences in ethnicity, language, and religion. In many cases these differences have not been politically or economically resolved. Divisions between Czechs and Slovaks, Hungarians and Romanians, Armenians and Asseris, Russians and Ukranians, to name a few, are likely to stymie economic rationalization. Perhaps the most poignant example is most of Yugoslavia, where civil war has halted economic reform.

The long-run economic choices of Eastern European countries will be restricted by the poverty and small size of most of the national markets in the region. To be competitive, industries in small countries must be active participants in foreign markets. Ideally, industries in small countries operate in a very open international market, buy where value is best, and sell internationally in niches. They must be outward-looking and dynamic: exactly the opposite of Eastern European large enterprises.

The industrial structures of Eastern Europe did not develop according to classic economic logic; they were defined by planned linkages within the regions of the ex-Soviet empire. Isolated from world markets, large firms produced goods made better and cheaper abroad. They operated in captive markets and exported on a large scale to similarly noncompetitive markets. They learned to operate with constant output and input prices and virtually unlimited access to credit. Sooner or later, many of those companies must be eliminated as national resources are channelled into products where the Eastern European countries are likely to have a competitive advantage, not just compared with one another but compared with the entire world. As one big firm in the region tries to improve itself by buying quality components from the world market, it dries up the markets for the other large firms, its traditional suppliers. When local consumers get a little real money and the chance to buy coveted imported goods rather than generally lower quality local products, the entire system collapses.

These old networks are now completely severed. As a result, Eastern European companies have lost the only conceivable buyers for much of what they produce. The problem is not simply one of price efficiency: it is one of political borders and disruption. Even a substantial increase in efficiency will not make up for the tattered regional industrial structure. It takes years to build a new structure, and a new structure cannot be built until the political uncertainty is overcome. Private investment--obtained in a real capital market--won't be readily forthcoming in newly privatized companies that are unsure of where their markets lie, where their sources of supply are located, or who their competitors are.

These seven obstacles would deter the most ardent reformers from attempting a program of drastic and potentially all-or-nothing industrial change. But the radical capitalists argue that it is essential to privatize quickly precisely because of such problems. That prescription might be tenable given a stable institutional setting with stable national boundaries and political systems, functioning tax codes, financial and legal systems, and broad-based capital markets, as well as plausible networks of international markets and industrial linkages. But there are few credible tested institutions. Without them, rapid privatization won't provide a solid base for prosperity, nor will it aid the development of independent entrepreneurs.


THE CRUCIAL ROLE OF CAPITAL MARKETS

Capital markets, just one of the absent institutions, invite particular attention. Price-driven capital markets are dear to the hearts of privatizers. Capital markets remove power, in giant dollops, from the hands of entrenched bureaucracies. They are fast, powerful, and provide invisibility for the market movers. It is difficult for a public bureaucracy to close down the only industry in a midwestern American town; that now-familiar objective is more easily achieved by a twitch on the Tokyo or New York stock exchange.

In capitalist economies, broad-based equity markets serve both investors and corporations in several ways. First, equity markets signal the underlying value of securities. Theoretically, this facilitates the proper allocation of resources by providing both investors and companies opportunities to raise cash as well as to spread resources among businesses that vary by product line and investment risk. Accurate share valuations provide stockholders with a de facto evaluation of management, which may sometimes precipitate corrective action. Second, equity markets provide avenues for companies to raise capital (equity or debt) from a wide net of investors. By the same token, equity markets enable investors to control risk in their portfolio more easily. Finally, equity markets ease the costs of investment and corporate restructuring by providing liquidity to both investors and corporations.

Because they are so powerful, capital markets are dangerous, especially when they lack proper safeguards and depth. In the lands of the ex-Soviet empire, the hazards are particularly acute because of the complete lack of experience in using these markets. Additionally, capital markets are likely to attract more attention than usual because of their novelty in the region and their significance as a capitalist symbol. Radical capitalists assume, correctly in our view, that capital markets will arise concurrently with privatization and the issuance of shares. Despite few viable companies, public stock markets are being organized in most of the countries.

Unfortunately, in spite of good intentions, these equity markets probably won't be able to perform efficiently--and just may perform with delegitimating perversity. It will be virtually impossible to establish fair market value for the exchange's listed companies given the shortage of capital in the region and the unstable business conditions. The lack of well-established, highly capitalized market participants implies that there will be a lack of liquidity in the equity markets. This will produce thin equity markets and wild price swings. The inexperience of the traders may also increase the likelihood of price gyrations.

Corruption is sure to become a big problem. Inexperienced market regulators will not be able to police markets that are moving quickly and without apparent reason. Market rigging and stock manipulation are inevitable. As most experienced traders will attest, financial market operations are very complex and enforcing fair rules can be nearly impossible. The first rounds of stock market activity are sure to see managers and their invisible partners in the administration cash in big. A crop of instant millionaires--whom everyone knew as the old nomenklatura--will become conspicuous symbols to be manipulated by potential demagogues.

If the resentment against black marketeers in Russia is any indication, there will be a groundswell against the "excessive" greed and corruption in the equity markets. Legitimate operators could get caught up in the popular outrage; so might the whole reform movement, especially in the context of large-scale economic misery and uncertainty experienced "by honest, hard working, native people."

Until a viable equity market is operational, companies will go elsewhere to raise capital or sell assets--by privately placing equity or raising capital through debt rather than equity. However, whereas in the West, market valuations can be made quickly due to the relatively free flow of information and the efficiency of markets, in the East, market valuations will be much more problematic. The lack of accepted accounting standards and a credible tax system will exacerbate the problem. These added uncertainties will make it much tougher to raise capital. Under these conditions, big firms will have no choice but to rely on the state, or in special cases private banks or foreigners, for their capital requirements. The investment policy of the newly privatized enterprise is likely to become dependent on the state. Independent active ownership may become an illusion, despite rapid privatization.


PUBLIC ENTERPRISES RECONSIDERED

Radical capitalists insist that state ownership and capitalism don't mix, nor do state ownership and rapid development. In their view, the Communist economic malaise is just another failure of state ownership. Throughout the world, and in the Third World in particular, they argue, stated-owned industries are notoriously inefficient and corrupt. Little wonder that many poor nations, as diverse as India, Turkey, and Mexico, have embarked quite successfully on massive privatization programs in recent years.

Yet state ownership makes sense at certain times under certain conditions. For instance, when markets are imperfect and capital scarce, institutional malfunctions may channel investment away from industries that are key to long-term development. In several countries, a sudden implosion of whole sectors, sometimes whole sets of sectors, has resulted in the state finding itself forced to step in and nationalize the losers. Hence the typical state sector, with its portfolio of coal mines, steel mills, railways, and shipbuilding docks. Italy and Spain have lavish government portfolios so acquired. This history of nationalizing dying industries in response to political pressures or more simply of managing the difficult task of restructuring and downsizing as painlessly as possible has given state-owned enterprises their bad name. They are, most often, collections of basket cases that no one else would take. This is what makes their experience particularly relevant to the former Communist realm.

There are, however, other examples of state-owned companies, nationalized for one reason or another, that were not already dying. France provides the best examples, and the history has been anything but negative. As late as 30 years after World War II, the French state still owned all or major firms in steel, coal, oil distribution, transportation, automobiles, cigarettes, electronics, ocean shipping, aircraft, skyscraper office development, radio and television broadcasting, telephone services, gas, electricity, plus, horrid as it may seem, most big banks and insurance companies. This is a partial list. The postwar modernization, restructuring, and growth of the French economy has been, by anyone's standards (except Japan's) extraordinarily successful. What is more, state-owned firms played a leading role, not simply a shock-absorbing role, in that transformation and modernization.

In Japan and Korea, the giant industrial groupings that dominate the economy defy simple classification as private or public. Nor is there any compelling reason to make the distinction. Surely the great Japanese keiretsu are not public firms; the government does not own them. But it is extremely difficult to assimilate the Sumitomo or Mitsubishi groups into the traditional category of a private firm. The market is not the opposite of the government; the firm is not in opposition to the state. There are many varieties of institutional arrangements, and they change with time and circumstance. The all-or-nothing dichotomy of public bureaucracy or private (capital market based) firm is dangerously simplistic--especially as a guide for Eastern Europe, where capitalism does not yet exist. It pops out of textbook economics, not out of the history of successful economic development, especially "catch-up" development. That is the relevant genre: the people of Eastern Europe do not have to invent their positive future--just catch up with it.

What determines the success of state-owned enterprises? State-operated industries can be operated efficiently or inefficiently, using technologically advanced production techniques or backward ones. Empirically, the answer is clear. Good performance is a function of the domestic political economy and its institutions, not just of the nature of ownership. Drawing from a cross-national collection of case studies of privatization, Raymond Vernon in The Promise of Privatization concluded:

Where governments have been reasonably competent and responsible, and where comparisons between private enterprises and state-owned enterprises have been possible, the technical performance of state-owned enterprises has not appeared much different from that of private enterprises. Here and there a strikingly efficient performance by a state-owned enterprise has cast doubt on the simple stereotypes of the public enterprise as a perennial wastrel.

In certain circumstances, reliance on the public sector and public ownership, in particular, may actually be good strategy. State ownership is certainly not to be sought as an end in itself; nor for the matter is private ownership of large enterprises. It all depends on the context in which choices must be made. Where private ownership seems doomed to fail--as in the case of many large enterprises in the ex-Soviet empire--the failure will result in a sudden implosion of the economy and society. In these cases, alternatives to simple privatization should be sought.

Further, the recent surge of privatization throughout Europe, Japan, and the Third World indicates that state ownership need not be permanent. Those trying to design new systems might profitably sift the rich varieties of institutional experience of other countries to see what made for better or worse performance: from state-owned, state-regulated, state-controlled, or state-in-cahoots-with. Ownership is a complex concept, contingent on embedded institutions. Given current conditions for big industry in the former Communist realms, some state ownership may be more desirable than simple "private ownership." Indeed, the logic of privatization in those lands does not ensure a dynamic market economy dominated by private firms. More likely, rapid privatization would precipitate state re-intervention sooner or later.


THE FAULTY INSTITUTIONAL LOGIC OF

RAPID PRIVATIZATION

The focus on privatization, especially rapid privatization, diverts attention from implementation of policies and creation of market firms and institutions that encourage the development of competitive industries and an effective state bureaucracy to ensure viable democratic societies.

More than increasing efficiency expected from privatization, these troubled nations need the benefit of rebuilding the networks of industrial linkages and trade within the region. They need outlets for goods--such as steel, ships, coal, and especially agriculture--to Western Europe; this will not be easy to obtain. They will need import controls so all savings won't wash out quickly in a wave of consumer buying, and most likely controls on capital outflows too. More than anything, they need a competent and honest public administration to recreate those international linkages, administer those controls, negotiate those trade agreements, regulate the new and wildly imperfect markets, and buffer the shocks of industrial restructuring.

To the radical capitalists, rapid privatization is a shortcut. Eliminate the state, and voila, economic growth. But this is myth, ideology. The state will not whither away despite the dreams of radical capitalists any more than it did despite the dreams of Karl Marx. The state will run things for a long time, if not as owner, then as regulator.

Ironically, the logic of rapid privatization does not make the dependence of industry on the state any less likely. The state is destined to be the key economic player for the foreseeable future, whether privatization be rapid or gradual. Newly privatized giant enterprises will depend on the state for financing and for establishing rules and regulations. The state will also maintain a heavy hand in the industrial core of the economy because the inherited industrial structure provides most industries with too few firms for successful self-regulation by competition. And regulation by foreign competition may prove fatal.

Just as the state will necessarily be interventionist, given rapid privatization, so it will be protectionist. Assisted by their new armies of shareholders, the newly privatized enterprises, unfit to meet foreign competition, are likely to press for protectionist measures, especially since competing in an open economy would be suicidal. Free competition would open the field for Japan, the newly industrialized countries, and other low-cost, high-quality producers and leave little chance for inefficient domestic producers. They are inefficient now, and by world standards, they will be inefficient and uncompetitive for the near term. One must recall that Japan, Korea, France, and Germany never exposed their "infant industries" to the rigors of foreign competition; nor will most of the struggling new nations of the ex-Communist bloc.

Finally, rapid privatization plans aren't necessarily conducive to narrow, active, and independent ownership. Some rapid privatization plans envision ownership through mutual funds or through national distribution of share vouchers. In either case, there is no guarantee that active, independent ownership pressing for dynamic restructuring will emerge. Mutual funds owning shares in many firms, as in the Czech plan, may react to poor performance by selling shares, not necessarily by restructuring industry. If they don't, or are not allowed to, they become more like Italy's I.R.I. than a Wall Street fund. More important, the mutual funds (even with foreign advisers) are likely to advocate conservative measures for change due to the dependence of enterprises on the state and perhaps ultimately on the workers.

Grand designs are associated with great risk. So it was with Communism, so it will be with capitalism. The radical capitalists' fallacy is that pragmatism will ultimately result in the loss of discipline as local interests forestall change. Their concern is valid, but their prescription is not. The risks associated with rapid privatization skew the odds toward failure and ultimately toward disenchantment with capitalism and a democratic, more liberal state.

The big, inefficient state enterprises will not succeed as private enterprises. But they cannot simply be abolished. Building the structures of capitalism, the institutions of a functioning market system, will take time and breathing room. Radically pure markets won't build them; they will destroy those structures and risk ending the capitalist experiment before it has had a chance to develop into something worthwhile. It was no less than Joseph Schumpeter, the great advocate of entrepreneurial capitalism, in his brilliant case for maintaining less-than-perfect markets, who remarked: "You put brakes on a car so that it can go faster, not slower."

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