# I. **INTRODUCTION**

A centerpiece of Russia's real sector reforms-the privatization of 15,000 enterprises through vouchers-was to make the transition to a market credible, irreversible, and rapid. The objective of the mass privatization program (MPP) was to establish a critical mass of profit-seeking corporations, no longer dependent upon state support for their survival, and a class of owners willing to invest in their enterprises and manage their restructuring.' The Russian MPP, however, has brought few tangible benefits to enterprises privatized in voucher auctions. Ineffective corporate governance, little new investment, and the distortions of continuing government intervention have limited the amount of restructuring these firms could undertake in practice. A diverse constellation of indicators now suggests that, among firms in other transition countries of comparable wealth, Russian firms are ranked at the bottom in terms of output, factor productivity, profitability, and cost efficiency. Recent surveys of Russian industrial sectors, moreover, conclude that the policies of regional governments tend to favor lowproductivity incumbents, protecting them from takeovers and more productive new entrants.<sup>2</sup> In this paper we suggest that the absence of restructuring and investment are the consequences of interactions between insiders (manager-owners), and regional governments within a particular property rights system. Two inter-related features of this system are consequential to the Russian real-sector problem. First, regional governments still use enterprises to protect local employment. In the Russian regions, govermments face a tradeoff between enforcing cash-based tax collections and maximizing tax revenues, on the one hand, and extracting "social" benefits in the form of excess employment on the other. If the managers-owners were to maximize the value of the firm, the firm would be left vulnerable to expropriatory policies that alter the net return on investment-e.g., restrictions on layoffs, costly regulations or tariffs, etc. Anticipating that, managers choose instead to maximize the private benefits of control, and no restructuring is accomplished. The regional governments, knowing that the taxable revenue of the firm will have been reduced as a result of cash-flow diversion, respond by collecting revenues in kind and enacting policies that force firms to maintain employment levels. These regional governments, then, are as "vested" in maintaining the status quo as are enterprise insiders, and will willingly shield insiders from takeover attempts, obstruct the enforcement of outsider's property rights, and perpetuate the l Among the purported benefits of vouchers: "[T]o sever the links between the state and the enterprises, to school the population in market basics, and to foster further ownership change. . ." See, e.g., Cheryl W. Gray, "In Search of Owners: Privatization and Corporate Governance in Transition Economies," _World Bank Research Observer_ 11, 2 (1996): 179-197.

2 See, e.g., McKinsey & Co., _Unlocking Economic Growth in Russia_ (Moscow: McKinsey Global Institute, 1999), which points out that Russia's labor productivity has fallen from 30% of the U.S. level in 1991 to 19% in 1997. Other surveys can be found in EBRD, _Transition Report 1998_ (London: EBRD, 1999), p. 130; Simon Commander and Andrei Tolstopiatenko, "Enterprise Restructuring and the Structure of Compensation: Why is Unemployment Low in the FSU?" World Bank, 1996; John Earle and Saul Estrin, "After Voucher Privatization: The Structure of Corporate Ownership in Russian Manufacturing Industry," 1997.

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