Transforming Post-Communist Political Economies (1998) / Chapter Skim
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Restructing Production Without Market Infrastructure
Restructing Production Without Market Infrastructure
Pages 131-155
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From page 131... ...
III Transforming Management, Labor, and Production
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From page 133... ...
Several of the Eastern European and Baltic countries are succeeding in building a healthy private sector and reorienting economic activity to the world market. However, although Russia and many of the republics of the former Soviet Union have pursued privatization with no less vigor, a successful restructuring of production continues to elude them.
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From page 134... ...
Creation of a nonstate sector implies an end to the state's monopoly on ownership of productive resources and the emergence of private owners with the incentive to use resources productively. But establishment of private property rights requires legal, financial, and administrative infrastructure to define and enforce ownership rights.
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The second stage of economic reform involves a still more difficult process, the reallocation of labor, capital, and management from subsidized state sectors to expanding export and consumer-oriented sectors. Eastern Europe has had considerable success in mobilizing domestic saving and attracting foreign investment, while Russia and the Commonwealth of Independent States continue to suffer capital flight.
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Decentralization, attempted by Khrushchev and Gorbachev, limits influence activities by eliminating the central authority altogether, but decentralization when there are no markets leaves decentralized actors without effective means of coordination. The informal economy is a product of this need for horizontal links.
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In this system, political power was used by party bosses, state officials, and the police to acquire and safeguard private wealth. The alternative to political capitalism is legal private property.
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While in theory the enterprise manager had few control rights over resources, in practice his control over information and his ability to trade off unmeasured dimensions of performance against measured performance indicators gave him substantial benefits of ownership. On the other hand, as central authority deteriorated in the 1980s and as nominal price controls created increasing excess demand, managers more and more frequently had to bribe allocators to gain access to supplies (Shleifer and Vishny, 1994; Boycko et al., 1995~.
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But when the formal rules of the game conflict with individual selfinterest, individuals will have incentives to evade the rules and, if there are penalties for evasion, to conceal their actions. The vast gulf between the formal rules and the de facto practice of the command system tells us that the perceived benefits of violating the rules were sufficiently large to outweigh significant penalties, which were enforced with high levels of monitoring.
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For example, low-cost producers will seek to conceal their true profits in order to retain a larger share, while government principals may seek to hide the true value of centralized resource rents from both enterprises and regional authorities who enjoy some de facto control rights to local resources. Since agents have incentives to divert resources from joint activities to their separate benefit, the authorities will attempt to create strong restrictions to local initiative.
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Moreover, differences in initial endowments and tastes for risk and incentives to enjoy specialization and economies of scale will lead individuals to establish institutional arrangements that allow them to partition property rights in a variety of different ways. If the institutional framework allows, an owner may choose to farm her land herself or to hire a tenant.
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In its formal constitution and laws, the Soviet state was similar to other modern states, with a legislature, a state administration responsible for applying the laws, and a judiciary. But in its de facto practice, rule making and enforcement were under the control of a closely entwined bureaucracy that united Communist Party monopoly of power with centralized state administration.
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In the process, firms accounting for two-thirds of the Russian industrial labor force were privatized, and over 50 million Russians became shareholders in either privatized enterprises or the investment funds that held equities. The privatization legislation was a vital first step in codifying property rights in productive assets.
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On the one hand, privatization created a constituency favoring property rights in small-scale assets, but the unequal distribution of wealth created another political constituency opposing private ownership of large firms and land. Restructuring of Existing Firms Will privatization lead existing Russian firms to restructure themselves?
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The weaker is corporate governance; the more concentrated must be ownership. In practice, ownership rights in larger Russian firms are split among several groups, and the legal and financial infrastructure needed to support governance is just beginning to emerge.
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Only when such a substantial restructuring appears probable will outside investors be willing to risk capital in the privatized firm to accomplish the necessary renovation. These changes, again, require market-supporting infrastructure and a market-oriented state.
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In the past 8 years, in spite of weak infrastructure, Russia has seen the rapid appearance of financial institutions, some of which have quickly developed the capacity to become participants in Western-style financial markets. These include more than 2,500 commercial banks, over 600 investment funds, over 1,000 licensed insurance companies, and more than 60 stock exchanges (down from 109 in 1993~.
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First, legal infrastructure must allow property rights to be defined clearly, enforced at reasonable cost, and transferable. This requires that market participants agree to a set of rules guiding procedures for reporting of price, trading, clearing, and settlement in order to reduce the risk of fraud and of insider trading.
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shows that an emerging demand for financial institutions led to the commercialization and privatization of state-owned banks more rapidly and irreversibly than in other reforming economies. Over half of all Russian banks operating today originated in the private sector, with over 75 percent of banking assets under the control of private investors.
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In the case of bank credit, Abarbanell and Meyendorff observe that the initial franchise value of Mosbusinessbank was based on the strength of management's relations with ministries and local government officials, and find a large number of cross-holdings and cross-governance relationships in the bank's ownership structure and investment portfolio. Profitable bank operations in the period 1992-1995 were at least partly linked to the federal government's policy of funneling directed credits to troubled enterprises through the banks, using central bank loans for leverage.
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Product Market Discipline To date, a competitive product market provides a stronger source of market discipline in Russia than does a competitive financial market. Rapid domestic price liberalization and more gradual trade liberalization force firms to compete with both import and export alternatives.
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. Operating with Weak Legal Infrastructure In the absence of a legal framework to structure relationships, resolve disputes, and enforce contracts, Russian enterprises seek strategies for operating without using law and legal institutions.
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Another recent study of business strategy in an environment with missing infrastructure finds that Russian firms set up links with foreign firms in order to gain access to the institutional infrastructure of the world market (Thornton and Mikheeva, in press)
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But until Russia extends property rights in land and acquires the administrative capacity to provide essential marketsupporting institutions, newly pnvatized firms will not have the incentive to provide greater transparency or face the discipline of competitive markets. Investment, structural change, and renewed economic growth will emerge if self-interested owners and investors are able to design self-enforcing institutions of corporate governance, build the legal institutions required to enforce contracts, and provide secure and transparent capital markets.
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1995 Capital markets development and financing Russia's transformation.
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