12 and (ii) new private companies are the best performers,<sup>followedby newly privatizedfirms run</sup> by outsiders (local or foreign).

# **Box 2: Russian Privatization**

In Russia, over 70 percent of enterprises became<sup>insider ownedfollowingvoucherprivatizationin1992-94.The</sup> hope and expectation was that these inside owners<sup>wouldopen theirfirms tooutsidersendowedwith moneyand</sup> expertise. Newly formed investment funds were expected<sup>to assistin thisprocess.Butinsidersproved reluctant</sup> to give up control, and outside investors were in<sup>anycase highly waryin thedeeplyunsettledandoftenlawless</sup> circumstances. As a result, neither new investors<sup>norRussianinvestmentfundssucceededinchanging and</sup> concentrating ownership in the secondary market.<sup>Theupshotwaslimited restructuring. Subsequentandnon-</sup> transparent cash sales of the larger enterprises in Russia-the<sup>notorious "loans-for-shares"program-assistedor</sup> actually created a "kieptocracy," meaning many<sup>high potentialfirms weretransferredtoasmallgroupof</sup> investors at low prices (Black, Kraakman and Tarassova,<sup>2000).</sup> Some analysts (Barberis, Boycko, Shleifer, and Tsukanova, 1996; Earle, 1998; Earle and Estrin, 1998)<sup>nonethelessconclude that privatizationled to performance</sup> improvements in Russia, at least in firms where outsiders<sup>succeededagainstoddsinsecuringcontrol,though</sup> they too acknowledge that many of these new<sup>owners did not payanythingneara reasonablepricefor the firms</sup> obtained; and the sales methods were non-transparent..

What can one say with certainty about the difficult<sup>andcomplexRussiancase? Itisclearthatprivatization,</sup> competition and hardening of budget constraints<sup>allimproveefficiencyinRussia.Increasesinprivateshare</sup> ownership raises real sales per employee, while<sup>subsidiesreducethepaceofrestructuring(Djankov,1999a).</sup> Significant foreign ownership (greater than 30<sup>percent),ispositively related torestructuring.</sup> Managerial ownership is positively related to restructuring at low<sup>levels(lessthan10percent)andhighlevelsof ownership.</sup> Had Russia been able to auction off transparently<sup>moreof itshighpotentialassetstocore, preferablyforeign</sup> investors, the economy would have been better off<sup>today,wouldprobablyhavereturned topositivegrowthearlier</sup> than it did, and might have avoided some of<sup>theacutepainsufferedbylargeelementsof thepopulation.</sup> Whether or not that course of action was possible is<sup>hard todetermineevenin retrospect</sup> Two questions ultimately arise: (i) did privatization<sup>leadtoincreased efficiency?and(ii)diditlead toincreased</sup> equity and/or welfare? All observers agree that Russian methods of privatization<sup>dramatically</sup> increased inequity. But what was the reasonable alternative?<sup>Continuedstateownership?Onecanmakeacasethatthe</sup> very corrupt and unfair "loans-for shares" privatizations<sup>inRussia eventuallyresultedinincreased efficiencyin</sup> the ftrms taken over. How so? The managers put in<sup>placeby the"oligarchs"areshowing themselves to bebetter</sup> managers than those provided previously by the<sup>state.</sup> The owners and managers of these firms have now become-after their initial and unjust acquisition of<sup>assetsandsomeyearsof "wildeasf'behavior-more</sup> interested in profits and protecting the long-run<sup>healthof theassetsthroughorderlyandlegally regulated market</sup> behavior. Recent evidence suggests that almost all<sup>thefirmsprivatizedthroughloansforsharesarenowrunning</sup> profits and are much healthier than they were as SOEs.<sup>True,the presentownerspaidvery littlefor thesevery</sup> high potential assets, meaning that the state-and<sup>thetaxpayers-obtainedverylittleinthe transfer.Moreover,</sup> the experience soured the Russian public on reform, privatization,<sup>andthehonestyandcompetenceof both</sup> officials and the private sector in general.

The overall point is that Russian privatization should<sup>ideally havebeenbetter managed,and that themanner in</sup> which much of it was carried out entailed high social<sup>andpoliticalcosts,the ramificationsof which are stillbeing</sup> worked out. Nonetheless, to conclude that Russia should<sup>not have privatized,that itshould have retaineda mass</sup> of firms in state hands while it tried to reform slowly<sup>andcreatean institutionalsettingmoreconduciveto decent</sup> transactions, may well have been an unrealistic alternative,<sup>as evidenced by thepoor andunsustainablerecordsof</sup> Belarus and Uzbekistan-countries that tried the "go slow"<sup>approach.</sup> Source: Nellis, forthcoming