Privatization and Entrepreneurship

The Managerial Challenge in Central and Eastern Europe

Erdener Kaynak, Alfred Lewis, Arieh A Ullmann

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781135840198
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Privatization and Entrepreneurship: The Managerial Challenge in Central and Eastern Europe analyzes the challenges faced by managers in the transforming economies of Central and Eastern Europe and provides penetrating insights into the details of managing in the former socialist countries. This collection's combination of conceptual/theoretical material with empirical, firsthand case analysis prepares Western managers for a more profitable and less stressful entry into these significant markets.This enlightening book highlights the complexity and breadth of the issues and problems of successfully entering new markets in Central and Eastern Europe. Along the way, you are introduced to such topics as consumer behavior and shown the different forms of foreign direct investment with their associated problems and benefits. If you are searching for ways to better prepare for business in these markets, this book can help you meet your objectives with its helpful information on:

• ethical concerns and linguistic difficulties of managing in transforming economies
• management challenges of privatization
• management challenges of entrepreneurship
• strategic issues associated with the reorientation of enterprises
• corporate constituencies, changing consumers, labor unions, and pay practicesPrivatization and Entrepreneurship will prove valuable to policymakers in economic development and foreign aid agencies, executives of companies planning to expand into Europe and those already active in the region, and academicians and students in management, economics, and political science.

PART I:

PREREQUISITES FOR MANAGEMENT TRANSITION

Chapter 1

Ethical Problems When Moving to Markets: Gaining Efficiency While Keeping an Eye on Distributive Justice

Norman Frohlich
Joe A. Oppenheimer

For more than 40 years after World War II, almost half the world’s population operated under autocratically governed command economies. In those countries the means of production were owned by the state, purportedly in the collective name of the people. As is well known, most of those political regimes suffered a rapid disintegration in the late 1980s and early 1990s. In the end, command economies were unable to keep their core promise: a minimally acceptable standard of living for all.

It is widely acknowledged that the socialist economies of Central and Eastern Europe in the 1980s were grossly inefficient. Western economists, secure in their theories, have advocated wide-scale privatization to increase efficiency. This chapter raises questions about the applicability of those models in the European context. Evidence of massive numbers of losers in the process of privatization leads us to raise two troubling issues. The first question is an epistemological one regarding the validity of applying a theoretical model when the antecedent conditions of the theory are wildly at variance with those that obtain in the domain of application. The second, which follows from the first, focuses on a normative aspect of the problem: How can a policymaker adjudicate between norms of distributive justice and promises of efficiency? If efficiency gains claimed for some future point arc accompanied by decreasing social welfare in the present, and if there is no compensation for those who suffer net losses in the process, then it is impossible to make a decisive claim that social welfare has improved. Without that, one cannot even claim improvements under the traditional welfare economic definition of efficiency.

CAUSES OF ECONOMIC DECLINE

It is easy to understand what happened in the Central and Eastern European economies. The means of production were owned by the state. One of the main ideological justifications for state ownership was the state’s commitment to use proceeds from the collectively owned goods to furnish economic entitlements–a welfare floor–to all. This manner of organizing production required that the productivity of the system was sufficient to generate the social welfare subsidies legitimating the governments. But the command form of organizing production and distribution, along with policies of setting prices according to social and political considerations, produced two damaging consequences:

1. Wages and benefits were divorced from individual productivity. This removed incentives for innovation and created conditions under which individuals could free ride. As a result, many feasible gains in productivity from labor were forgone.

2. The lack of market signals also led to the misallocation of other factors of production. This resulted in the further reduction of both productivity and the general welfare.

The first consequence rendered the entire command economy a giant “commons” problem.¹ The outputs of the command economies declined to a point where they were barely adequate to guarantee a minimally acceptable standard of living. They even threatened the supply of goods deemed to be inherent rights: food, medical care, and housing, components of the implicit social contract.

THE PRESCRIPTIONS AND THE FIRST RETURNS FROM PRIVATIZATION

The classic suggestion for dealing with a commons problem is to introduce market signals through privatization (Hardin, 1968). Entitling the participants to specific portions of the resources, and giving them the rights to trade these entitlements, generates incentives to move to an efficient outcome. The same policy is usually presumed to be applicable to the general holdings in the command economies of Central and Eastern Europe. The prescribed solution for managers of the economy is to privatize and introduce markets for trading the newly privatized resources.

It was anticipated that such policies would be associated with some manageable short-term disruptions, and then with medium- and long-term overall economic improvements that would produce significant gains in output and welfare. That was the theory. The process that has been unfolding is somewhat different.

Privatization has shown some immediate positive effects, such as the availability of certain consumer goods, and the enrichment of successful entrepreneurs. At the same time, privatization has led to the impoverishment of a significant proportion of the population. While some of the welfare setbacks may be transitory, there are no theoretical guarantees about their duration, much less about their political impact. One commentator has noted: “The almost Dickensian division of Russia into two nations–the conspicuously rich and the desperately poor–threatens to become a source of major social tension that could push the government into reintroducing elements of the discredited communist system of centralized distribution” (Dobbs, 1992). And the hardships of the transition may not be strictly short-term. As a former Polish ambassador stated: “Liberty has its price and the price is high. We knew the poor would suffer but we thought it would be two or three years. Now it’s beginning to look like 10 or 20” (Darnton, 1993).

The changes in the economies of Central and Eastern Europe have led to a small class of big winners and a large class of economic losers: some with radically lowered economic status and expectations. Competition has been far from perfect; often some state monopolies have been replaced with private ones. Given the gravity of the situation, a closer look at the reflexive support for the policy of unfettered privatization as social policy is in order. One is moved to ask: What are the implicit arguments underlying the prescriptions of privatization offered by Western economists? Are there some possible lacunae in those arguments that might account for the problems being encountered?

WHY ARE THERE PROBLEMS WITH PRIVATIZATION?

Economists are accustomed to thinking about free market systems in equilibrium: systems in which transactions are fluid and costless, and information is available and accurate. Under those circumstances, markets operate efficiently and lead to optimal results for the society. Identifying the assumptions of the traditional economic argument, and questioning their applicability in the Central and Eastern European context, can illuminate some of the problems of, and some of the normative premises implicit in, applying the arguments there.

From an economic point of view, the argument which justifies privatization is seemingly straightforward. It relies on exposing both labor and other factors of production to the rigors of the free market. Trades freely entered into can have no losers. Trading is the key liberal right that enables the system to overcome free-riding and inefficient allocation inherent in a command economy. People are free to enter and exit markets in accordance with their own desires: If a peasant enters a market with an endowment (say of millet), the argument goes, she cannot exit worse off than she was before she entered it. After all, the peasant need not accept any deal that does not improve her welfare. Similarly, buyers need not accept bad deals. Both buyer and seller are thereby given the potential only to improve by privatization and the existence of free markets.²

Privatization coupled with markets allows individuals to pursue trades until no more improving moves are possible. Typically, if one identifies the status quo welfare of all individuals at the start of the process, each move (trade) will be welfare-improving (a Pareto improvement) and the trades will cease only when no more welfare-improving trades are possible (on the Pareto frontier). When this has been achieved, the system is said to have reached an equilibrium at an optimal point. Given the standard assumptions of economics, as a solution to the problems of free-riding and inefficient allocation, market processes can be criticized only in terms of distributive criteria.³

But the arguments of the free market economist are usually framed in terms of what happens under perfect market conditions, not at the initiation of the market. It is assumed that there are many buyers and sellers, no barriers to entry, mobile labor and capital, and costless, perfect information about the availability and price of all factors. Given these assumptions, their theoretical conclusions are the inferences of valid arguments. If the premises of their model hold in any particular empirical situation, one would expect the conclusions to hold in that context as well. But economists fail to give adequate attention to the consequences of introducing trading of property in very imperfect markets–where the assumptions of their model do not hold. Note that it is the very imperfection of the markets in command economies that has led to the call for free market solutions. These imperfections mean, in reality and theory, that the models can guarantee neither that there will be no losers nor that the losses will be limited in time and scope.

Welfare economists agree that a particular new policy p is “an improvement” over the status quo, s, if everyone who is affected by p is at least as well off as under s, and at least one person is better off under p than under s. Assuming individuals prefer outcomes that make them better off, one would get unanimous agreement for shifts from s to p. Such changes are referred to as Paretian. They represent the easiest of all possible cases for the policymaker. These are the sorts of moves anticipated by the argument sketched above. And as long as we subscribe to some loose form of utilitarianism we should be supportive of such changes (see Arrow, 1963, Chapter 4).

Of course, there are still normative questions involved in policy choices here. Different Paretian policies will lead to different points on the welfare frontier, and have differing distributional outcomes. Many words have been written on the ethical questions of economic distribution. If we are primarily concerned with such issues as equality, or even relative well-being, there are many issues which the policy analyst must face.

Increasing evidence, both theoretical and empirical, shows that people place high normative valuations on general rules guaranteeing individuals some degree of economic safety. John Rawls (1971) argued that individuals have rights to the basic necessities of life–part of what he called primary goods. Focusing on societies which are at least moderately well off, Rawls argued that liberty, broadly defined, constituted the first requirement of any just society. Clearly the disestablishment of totalitarian rule was a prerequisite for the meeting of Rawls’ first set of desiderata. Following that, however, Rawls argued that goods in society must be distributed so that those at the bottom of the economic ladder are as well off as possible (in terms of those primary goods).⁴ So, for example, Rawlsians would not adopt Paretian policies if they didn’t lead to a maximum improvement of the welfare of the worst off. While the evidence suggests that Rawls’ description of what needs to be provided to the worst off is too generous, there are clear indications that a minimal safety net enjoys broad public support in most societies. Indeed, there is mounting evidence that virtually all individuals have normative social concerns regarding the setting of inviolable welfare floors (Frohlich and Oppenheimer, 1992).⁵

We have found that access to some minimum level of primary goods is generally viewed as a socially generated right in a broad range of societies (Frohlich and Oppenheimer, 1992; Jackson and Hill, 1995; Lissowski, Tyszka, and Okrasa, 1991; Saijo and Turnbull, 1994). Allowing an individual to receive less than that bundle of goods is morally unacceptable in those societies. Everyone is deemed to have the right to some acceptable level of food, water, shelter, medical care, etc. If privatization policies engender inequities that threaten this value, serious social tension over conflicts between efficiency and distributive justice are likely to result. The policymakers and managers will be stuck with the task of resolving these tensions.

THE PROBLEMS STEMMING FROM THE POSSIBILITY OF LOSERS

The perceptive reader might ask: “How can there be ‘losers’ under a policy of privatization when all trades are presumed to be welfare improving?” The answer lies in a close look at the real context of privatization.

Privatizing the rights to dispose of property does not create new property and an immediate gain in welfare. Rather, there is a distribution of property and an increase in the choices open to individuals to exchange property at market values, which fluctuate with market signals. Two problematic areas come to mind: first, the initial distribution of property bundles; and second, the changes in the value of the property over time.

Any reorganization which leads to a move from a suboptimal status quo s to a point p on the welfare frontier can be thought of as defining welfare trajectories for the members of the society. The points traced out over time as results of trades and economic activities constitute the trajectories (as well as the endpoints) of the process. They are the outcomes over time of the policies. They are experienced by the members of the society. Paths can be usefully distinguished as follows: (1) they can be Paretian (no one is made worse off), or not Paretian, where (2) some are made temporarily (or permanently) worse off, and if some are worse off, (3) they may fall temporarily (or permanently) below the socially acceptable welfare floor. If the paths are chosen with full information, only the Paretian paths are attainable via Pareto moves without compensatory redistribution. The other trajectories would require compensation to gain prior consent of those who will lose in the short or long run.

What factors would lead one to anticipate losers, i.e., individuals who fall below their status quo ante? To see how privatization under radically imperfect market conditions can create losses, even losses that threaten to drive some below a minimally acceptable floor, let us consider two phases of privatization. In phase 1, individuals receive a bundle of property and trading rights; in phase 2, they engage in trades. Seeing how an individual could suffer losses in the first stages of privatization is straightforward.

In the first place, losses could stem from misevaluations of the assigned bundles. After all, there are numerous imperfections, rigidities, and difficulties preventing an accurate estimation of the values of distributed assets absent market signals. Moreover, privileged segments of the population enjoy systematic and unfair advantages in parceling out the property and in early rounds of trading. Former party members and managers are likely to control vital information and key factors of production and thus often have the ability to enter into and monopolize certain forms of economic activity. Even if the policymakers try hard to be fair, the values of the privatized goods assigned to individuals are likely to be different than planned.

An additional loss of welfare could stem from a restriction on the ability to trade the privatized goods in the next phase. Information is highly restricted and concentrated and much of labor and capital are immobile. These inequalities can easily affect the subsequent value of any resources that may be distributed.

If the great bulk of individual entitlements is to stem from exchange, as it does in a pure market economy, the two sources for these entitlements will be the value of the allocated basket of newly privatized goods and the individual’s earned income. Each of these sources of exchange entitlement is also a source of risk.⁶ First, the basket of allocated privatized property is certain to fluctuate in value. Market values of goods change. That is the whole point. Hence, as the value of market-based exchanges shifts, gains, as well as losses, are produced. Entitlement to goods, including necessities in a pure market economy, are generated by the exchange value of each cit...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• About the Editors
• About the Contributors
• Introduction
• PART I: PREREQUISITES FOR MANAGEMENT TRANSITION
• PART II: MANAGEMENT CHALLENGES OF PRIVATIZATION
• PART III: MANAGEMENT CHALLENGES OF ENTREPRENEURSHIP
• PART IV: STRATEGIC AND OPERATIONAL REORIENTATION
• PART V: EMPLOYEES AND CONSUMERS IN A NEW CONTEXT
• Index