Russia is extremely important to the U.S. both politically and
economically. Politically, a stable and democratic Russia is crucial to
the security
of the United States and the world. Economically, Russia's vast
natural resources, particularly petroleum, and its population of 150
million, represent potentially lucrative business opportunities.
Yet, Russia presents many challenges. Politically, the first
challenge is its sluggish progress toward full democracy. One of the key
causes is the country's historical alienation from Western
ideologies and experiences, as well as its long history of rule by
dictatorships. Second, Russia's characteristic bravado and pride as
a nation, especially as a recent superpower, appear to foster a stance
in the global arena that worries and irritates the U.S. Third,
Russia's stockpiles of nuclear weapons and the suspected lax
security are continuous causes of concern. In the economic arena,
business opportunities come with many risks, including a lack of rule of
law, bureaucratic excesses, corruption, a lack of transparency and
accountability, crime, and physical danger to expatriate managers.
Notwithstanding these challenges, much progress has been made in
Russia. The country has become more stable, although many argue at the
expense of democracy. Investment is growing, and key sectors such as oil
are experiencing renewed vigor. Although criticism about the nature of
Russian privatization abounds (e.g., Chazan, 2002; Stiglitz, 1999),
progress has been made on this front as well. Since privatization
entered the so-called case-by-case phase in 1997, it is proceeding in a
more orderly, legal fashion. In addition, foreign investors can more
easily access information on enterprises available for privatization.
The authors believe that privatization is the key to the ultimate
economic prosperity and political reform of Russia. Therefore, for U.S.
businesses, much of the prospects for doing business with and in Russia
hinges on the success of privatization. The purpose of this article is
to educate decision-makers in U.S. firms on the vital processes of
Russian privatization, so that they will be able to make more informed
and accurate business decisions. To this end, we review the past and
present of Russian privatization and attempt some predictions on its
future.
Stages of Russian Privatization
A review of literature on Russian privatization reveals that before
it began on a large scale in 1992 there was a pre-privatization stage
called the commercialization stage (late 1980s-1992). Privatization
itself, which followed commercialization, consisted of three stages:
mass privatization (1992-1994), cash privatization (1994-1997), and
case-by-case privatization (1997-present) (Blasi, Kroumova, and Kruse,
1997; Puffer, McCarthy, and Naumov, 2000; Radygin, 1999)--see Table 1.
Commercialization (late 1980s-1992)
Having been state run for almost 70 years, the Russian economy in
the mid-1980s was on the brink of collapse. Implemented by the former
Communist Party Secretary Mikhail Gorbachev, the policies of glasnost
(openness) and perestroika (political and economic restructuring)
spearheaded profound changes in 1985, which were intensified during his
term as president of the USSR from 1988 to 1991.
The main goal of the government at this time, now referred to as
the commercialization stage, was building up capital to prepare the
country for subsequent privatization. One of the key policies was the
creation of cooperatives, small businesses, and joint ventures (Puffer
et al., 2000). As a result, this stage gave rise to many semi-private
enterprises and helped lay the foundation for real privatization.
Mass privatization (1992-1994)
Russian privatization was officially launched in October 1992, when
the voucher investment funds, known in Russia as "Check"
Investment Funds, were created under the Presidential Decree no. 1147.
To create vouchers, GKI (Goskomimushestvo--State Committee for Property
Management) valued all state property at 150 billion rubles using 1991
prices and divided that figure by Russia's population of 150
million--resulting in a share worth 10,000 rubles, the voucher's
face value (Williamson, 1998).
In October 1992 the Russian government began to distribute a
voucher to every citizen in bearer form with a nominal value of 10,000
rubles. The goal was to make all Russian citizens owners of private
property as quickly as possible with the least social conflicts. These
vouchers could be used to bid for and buy shares in companies at
privatization auctions and were a compulsory means of payment in the
privatization of 29% of state shares (Blasi et al., 1997). Voucher
validity was scheduled to expire July 1, 1994. In the 20 months of the
voucher program, the voucher price reached a low of $4 and a high of
more than $20 (Boycko, Shleifer, and Vishny, 1995).
The first pilot auctions were held in December of the same year
with participation confined to voucher owners. Citizens of Russia had
four options with the vouchers: (a) exchanging them for a share in
voucher investment funds, (b) selling them for cash on the street, (c)
exchanging them for a share in privatized companies or joint stock
companies, or (d) doing nothing, in which case the vouchers would lose
their value by their date of expiration. Many of them chose option (a),
because they had little idea about the quality of enterprises in which
they could potentially invest directly, and, therefore, they hoped that
professional managers of the voucher funds would make good choices for
them. These funds collected approximately one third of the 150 million
vouchers issued and at their peak represented nearly 25 million
shareholders, who had invested an average of two vouchers each (Cadogan
Financial, 2001). After collecting vouchers, voucher investment funds
participated in privatization auctions to exchange vouchers for shares
in privatized companies.
Results of mass privatization. Of the approximately 240,000
enterprises at the beginning of the privatization program, about 41%
were privatized, as of July 30, 1994 (the ending date of mass
privatization program). Under "small-scale privatization" more
than 50% of all small enterprises were privatized. Under
"large-scale privatization" more than 20,000 joint stock
companies were born out of medium and large state enterprises, and the
shares of 16,500 of them were offered during the voucher auctions
(Radygin, 1996). At the end of 1994 there were about 40 million
shareholders of the newly established joint stock companies or the
voucher investment funds (Kranz, 1994).
Faults of mass privatization. The process had a lot of faults,
beginning with the voucher investment funds. Although quite successful
in attracting investors, the funds never became a real investment
vehicle for Russian citizens (Cadogan Financial, 2001) for four reasons:
1) Only a few of the funds managed to get good quality shares at
privatization auctions. The majority, especially those based in the
outlying regions, ended up with stock of low value in small- and
medium-sized companies, many of which were not viable, at least in the
short term; 2) Shares in voucher funds were not traded on any market.
Therefore, original investors in voucher funds found themselves locked
into an investment vehicle of little value, often with no chance to get
rid of their investments even when they wanted to; 3) Voucher investment
funds were considered by the Russian Tax Authority as an ordinary
company subject to corporate tax as well as other taxes that, in
principle, had very little to do with fund activities. Therefore, they
were double - and sometimes triple - taxed, which made them an
unattractive and often not viable investment instrument; 4) Finally, due
to poor regulation of these funds, there were shareholder abuses of
various kinds. As the funds had very little value, many persuaded their
shareholders to turn them into ordinary companies or to liquidate.
Sometimes enterprises in which funds had investments ceased to exist.
Some fund managers disappeared, leaving funds with no cash but with
lists of liabilities and investments whose quality could be hardly
identified. From 662 voucher investment funds licensed between October
1992 and June 1994, there were around 300 funds at the end of October
1997, with about 17 million shareholders, worth 3 trillion rubles, or
$500 million at the then prevailing exchange rate (Cadogan Financial,
2001). As voucher investment funds were gradually eaten up by
unscrupulous managers and tax duties, only a few managed to pay
dividends.
The second fault of mass privatization in the eyes of critics was
that it legalized the stealing of property by the so-called "Red
Directors." These were Communist Party functionaries put in charge
of managing state enterprises in preprivatization days who, along with
the workers later became shareholders of their enterprises during
privatization. According to Grigory Yavlinsky, a leader of one of
Russia's political parties, what happened during this stage of
privatization was "collectivization," not privatization (The
Economist, 1994). It is estimated that more than 70% of the shares of
privatized companies ended up in the hands of enterprise managers and
workers (The Economist, 1994).
Third, during this period the number of so-called "New
Russians" (newly rich Russians, who got rich from various mostly
illegal schemes) greatly increased and corruption blossomed, creating
the infamous Russian mafia. According to the Academy of Sciences'
Institute of Sociology, the government believed in 1995 that criminal
organizations controlled over 50% of all economic entities. Blasi et al.
(1997) estimated that mafia had established control over 35,000 economic
entities, including 400 banks, 47 currency exchanges, and 1,500
enterprises in the state sector.
Fourth, even though it is undisputable that mass privatization in
Russia managed to shift ownership to private hands, most privatized
firms by the end of mass privatization were still operating like
state-owned enterprises. Instead of investing in the companies to make
them more competitive, the main aim of the new managers such as the Red
Directors was to strike a deal with their worker-shareholders that they
wouldn't be sacked as long as business continued as usual. Few
changed their product offerings in response to market needs, and most
factories continued to produce for inventory to maintain employment,
even though workers were often not paid on time (Puffer et al., 2000).
Cash privatization (1994-1997)
By July 1, 1994, mass privatization in Russia had been officially
complete. A new stage of privatization began with President
Yeltsin's Presidential Decree no. 1535 of July 22, 1994, called
"Basic Guidelines of the State Program of Privatization of the
State and Municipal Enterprises in the Russian Federation after July 1,
1994." This Decree defined the rules governing the new stage of
privatization known as cash privatization.
Despite the program's ostensible, repeatedly announced goal of
increased investment in enterprises to facilitate their restructuring,
the real goal turned into raising revenues to finance massive federal
budget deficits (Radygin, 1996). To this end, most economically
important enterprises, primarily in the natural resources, metallurgy,
telecommunications, high technology, and food industry sectors, were put
up for sale (Puffer et al., 2000).
Standard methods of sale. The enterprises were to be sold by a
sequence of three methods: (a) free transfer or sale of shares to the
employees through a closed subscription; (b) sale of equity (not less
than 15-25% of the charter capital) through investment tenders,
commercial tenders, or auctions; and (c) sale of the remaining shares at
the specialized auctions including ones that were interregional and
nationwide (Radygin, 1996). All enterprises with balance sheet value of
assets exceeding 20 million rubles as of January 1, 1994, were to be
transformed into open joint stock companies, and their shares could be
sold by any of the methods mentioned earlier. The rest of the
enterprises, with a value of less than 20 million rubles, were to be
privatized through auctions or commercial investment tenders (Radygin,
1996).
This stage was characterized by a struggle for absolute control
over the privatized companies. The interests of the state and those of
other shareholders were often in conflict over the choice of the sale
methods. Because of its need to secure revenues from the sale of its
stake, the state was interested in the auction-type methods. But
management, as one of the largest stockholder groups was interested in
retaining control, therefore, preferring investment and commercial
tenders that would give them an opportunity to formulate special
conditions tailored to their advantages. And the large outside
shareholders preferred specialized auctions that would allow them the
ability for sudden actions during the struggle for the offered stake.
A total of 831 specialized auctions (a cash variety of earlier
voucher auctions) were announced in 1995. The first interregional and
all-Russian auctions began in June of 1995, with 14 held by October, and
30 by year-end. Companies such as Energy System of Russia, Rostelekom,
Urlamash, Novorossiysk Shipping Company, and Vyborg Pulp and Paper
Plant, as well as oil companies were auctioned off as joint stock
companies (Radygin, 1996). There were 4,052 cash auctions in 1995 in
Russia - the most-used method of sale.
Loan-for-shares scheme. According to the loan-for-shares scheme
announced by Presidential Decree no. 478 of May 11, 1995, the
government's shares in 43 major enterprises were to be transferred
to a consortium of banks to be held in trust for five years in exchange
for low-interest loans to the government due in 2000. During the
five-year period, the government could sell the shares to investors and
buy back its shares from the banks. In reality, ownership of many
important enterprises was turned over to the banks when the loans
matured in 2000 (Sager, 1999).
Most of these banks got started and grew rapidly during the stages
of commercialization and voucher privatization. They had a powerful
lobby in various levels of government, including President
Yeltsin's closest advisers, and emerged as large
financial-industrial groups, which included Onexim Bank, Menatep,
Inkombank, and Alfa (Puffer et al., 2000).
Criticisms against loan-for-shares scheme. Considerable criticisms
accompanied this loan-for-shares scheme. First, many Russians refer to
it as "prikhvatizatsiia," or grab-itization--rather than
"privatizatsiia," or privatization--noting that banks simply
grabbed the largest, important enterprises in key industries (Sager,
1999). Second, this scheme was also associated with corruption. A major
corruption scandal broke out in 1997, when Anatoly Chubais, the then
Finance Minister, came under attack for taking a large fee for an
unpublished book. He and several other governmental officials reportedly
received $90,000 each for contributing to a yet-to-be-published book on
Russian privatization. The book payments were made by Segodnya Press, a
Russian publisher partly owned by an affiliate of Onexim bank, one of
Russia's largest banks and the winner of recent privatization
auctions. Following this scandal Chubais and other governmental
officials who had supposedly received payments were fired (CNN World
News, 1997 ).
Third, little was reinvested in developing the nation's
economy, even though huge financial transactions took place. Fourth,
according to the World Bank, $88.7 billion fled Russia from 1993 through
1996, and a later study by a team of Canadian and Russian academic
economists estimated the figure at $140 billion from 1992 to 1997
(Reddaway, 1998).
Most of the enterprises sold during this period, as mentioned, were
high-value energy companies, such as Norilsky Nickel and Sidanco Oil
Company. In 1995 alone 12 auctions contributed 5.1 trillion rubles to
the federal budget, accounting for 70% of that year's budget
revenues from privatization. The remaining 2.2 trillion rubles were
received from other cash sales, such as auctions and tenders (Radygin,
1996).
Case-by-case privatization (1997-present)
In 1997 Russian privatization entered yet another stage, the
case-by-case stage, characterized by stricter governmental control over
the sale of state property. Even though auctions and tender offers were
still the main sale methods, now the sale of large enterprises was
subject to careful pre-sale preparation. Each sale was to be treated
differently and governed by the rules and regulations tailored to it.
The aim was to enhance the attractiveness of the enterprises to be
privatized, raise the prices of the shares sold, and improve the
enterprises' liquidity. The measures included disclosure of
information on assets to be privatized, the involvement of auditing
companies and financial consultants, and the transfer of shares into a
trust through a tender, with the trustees obligated to raise the prices
of these shares. All enterprises pledged for sale by the Presidential
Decree No. 889 and not sold to this point were assigned to this scheme.
Results. In 1997 Russia received $4.2 billion in privatization
revenues, according to the World Bank's Global Development Finance
reports. The largest 1997 deal was the July auction of a blocking
interest (25% plus one share) in Svyazinvest, the state communications
company responsible for providing communication services throughout
Russia. Also in 1997 specialized cash auctions were arranged to sell
stakes in six large oil companies (Vostsibneftgaz, Vostochanaya
Neftyanaya Kompaniya, Siberian-Ural Petro-Gas-Chemical Company, Tyumen
Oil Company, Komi TEK, and Norsi-Oil) (Foreign Investment Promotion
Center, 2001). The sale was carried out under the control of the Russia
State Property Ministry (GKI), observing the principles of publicity and
openness.
In 1998 Russia earned only an estimated $909 million in
privatization revenues, partly because of the Russian financial
system's collapse in August 1998. Most of its revenues came from
the sale of a 2.5% share in Gasprom to Ruhrgas, and a 25% share of
cellular phone services company VimpelCom. However, the planned sales of
Rosneft (oil and gas), Svyazinvest (telecom), and Rosgosstrakh
(financial services) were all delayed (World Bank, 2000).
Foreign direct investment up to 1998 was disappointing, reaching
only $1.5 billion (Sager, 1999), and showed the failure of the
government to attract mass foreign investment in Russian companies. A
possible contributing factor was the Russian financial crisis in 1998,
which saw the government default on its internal and international
debts, ending an emerging financial stability and confidence in the
free-market economy. The political instability caused by President
Yeltsin's subsequent firing and appointing of four prime ministers
in the following 17 months also contributed to lower foreign direct
investment. Later on, however, devaluations spurred investment in plant
and equipment by Western companies as well as many Russian firms
(Tappan, 1998).
During this period money laundering schemes were uncovered when a
number of American, British, and Russian investigators announced that
there was "strong evidence" that 780 Russian officials used a
bond-selling scheme to send billions of dollars out of the country in
1998, only a few hours after the IMF deposited a $4.8 billion loan in
the Central Bank. The investigators also suspected that the Russian
mafia and Kremlin authorities may have siphoned as much as $15 billion
out of the country through the Bank of New York and other financial
institutions (Kelley and Stanglin, 1999).
People behind the privatization
The job of designing and implementing Russian privatization
programs was given to Anatoly B. Chubais, a 36-year-old economist and
former professor with the Leningrad Institute of Economics and
Engineering. He was appointed minister of privatization in November
1991. From 1990 to 1991, as an official in the city government of St.
Petersburg, he oversaw the privatization of shops and smaller
businesses. His top aides were Dmitry Vasiliev and Maxim Boycko.
Vasiliev served as deputy chairman of the privatization ministry, with
responsibilities for the implementation of the program, and Boycko
served as the Russian economist working on policy with Chubais's
American advisory team directed by Andrei Shieifer.
Chubais, one of the so-called "young reformers," was
popular in Western business and financial circles, because he was U.S.
educated and viewed as someone who got things done. In surveys conducted
in Russia, however, more than 80% of the respondents expressed
disapproval of his activities (Clarke, 1997). The reasons had to do not
only with the cynical and often hostile reception the Russian public
gave privatization, but also with Chubais's policies, personal
ties, and individual financial history (Clarke, 1997). Western,
particularly U.S., support for Young Reformers was thought by some
sources to have played a significant role in money laundering. By
designing corrupt transfers of state assets into a few privileged hands,
Western advisors were accused of serving as intermediaries to the birth
of corruption and such criminal acts as the capital flight from Russia
(Solnick, 1999).
Financial support for the privatization
Western financial institutions largely supported the Russian
privatization program. Since implementation required large financial
resources that were not available within Russia, financing was provided
primarily through loans from the World Bank Group.
Privatization implementation assistance project. The first such
loans made to the Russian government were through Privatization
Implementation Assistance Project, which furnished $90 million during
1992-1999 (World Bank, 2001). The central objective of these loans was
to provide substantial implementation assistance to the privatization
program during its initial and most critical phase. The loan provided
technical assistance for policy formulation in key areas complementary
to privatization, such as pro-competition policies, corporate
governance, portfolio management, inter-enterprise arrears, and
environmental issues associated with privatization; and also technical
and equipment assistance to help implement the privatization program at
the national, regional, and municipal levels.
Enterprise support project. This project provided Russia with $200
million starting in 1994 and ending in 2000. It provided term financing
for capital investments and permanent working capital to new private and
privatized enterprises.
G-7 program for privatization and restructuring. This program
provided equity financing, technical assistance, and export credit and
guarantees (World Bank, 2001).
Current Situations and Future Prospects
Prospects for the Russian privatization program look brighter than
10 years ago. Many laws have been passed to create legislative grounds
for the process, and controls over privatization have been tightened.
Prospects for 2002 revenues look good, with total revenues from selling
state property expected to reach 35 billion rubles (about $1.19
billion). A total of 365 public companies and 152 federal state unitary
enterprises are to be privatized. One hundred per cent of shares will be
sold in 340 public companies, while in the remaining 25 companies the
state will own more than 25%. As a result, the number of state companies
will be reduced by about 4% (RosBusiness Consulting, 2001).
Foreign investment is expected to increase, helped in part by the
recently created PrivatizationLink website. Since the levels of foreign
direct investment in Russia had not been as high as in other Eastern
European countries, the World Bank Group's Multilateral Investment
Guarantee Agency (MIGA) launched the PrivatizationLink Project. The
purpose was to develop and manage a Web site to facilitate continued
privatization and increase foreign investor involvement in developing
the private sector. The free Web site (privatizationlink.com) provides
updates on privatization-related investment opportunities and relevant
background information for investors interested in bidding for
enterprises to be sold. The ultimate goal is to encourage transparency
so that future case-by-case privatization efforts will be more
successful (Sager, 1999).
New managements in the privatized companies are finally
implementing necessary internal changes. They see that their efforts are
paying off, and it is up to them, as private owners, to manage their
enterprises to profitability. Average Russians are learning to function
in the market economy and profit from it, which in turn stimulates them
to support continued reforms. Even though the privatization process is
far from over, major milestones have been reached. Russia has accepted
the market economy and is moving toward making the new system of
privatized enterprises work.
Many U.S. companies such as McDonald's have enjoyed great
success in Russia, but many others stayed away due to unacceptable
levels of risks or other concerns. Still others left Russia after
experiencing unsatisfactory operational results. The authors believe
that U.S. companies should reassess their stance on Russia and seek
opportunities to benefit from its economy. The Russian market is simply
too important to ignore.
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Dr. Kim, professor of global and strategic management, has
published widely in the fields of organizational behavior, international
business, and cross-cultural management. Anna Yelkina, who came to the
U.S. from Russia in 1995, is a recent honors graduate in international
business and marketing and is employed by Pilkington North America.
Table 1
Stages of Russian Privatization and Their Goals, Methods, and Results
Stages Goals
Commercialization To build capital to prepare
(late 1980s-1992) for subsequent privatization
Mass Privatization To make Russian citizens
(1992-1994) owners of private property
as quickly as possible
Cash Privatization Ostensibly to create funds
(1994-1997) for restructuring enterprises;
in reality to close federal
budget deficits
Case-by-Case Privatization To raise the attractiveness
(1997-present) and prices of enterprises to
be privatized
Stages Methods Used
Commercialization Glasnost (openness) and
(late 1980s-1992) perestroika (restructuring)
Encourage creation of
cooperatives, small business,
and joint ventures
Mass Privatization A 10,000-rouble voucher
(1992-1994) issued to each citizen
Voucher Investment Funds
created Privatization
auctions conducted
Cash Privatization Selling important enterprises
(1994-1997) (natural resources,
metallurgy, telecom,
high-tech, food industries)
by:
Cash sales/auctions to
employees
Sales of equity through
tenders/auctions
Sale of the remaining shares
at specialized auctions
Loan-for-shares scheme
Case-by-Case Privatization Tender auctions carried out
(1997-present) after a careful pre-sale
preparation, governed by
rules and regulations
tailored to each auction.
Stages Results
Commercialization Creation of semi-private
(late 1980s-1992) enterprises
Laying the foundation for
privatization
Mass Privatization 41% of 240,000 large
(1992-1994) enterprises were privatized
50% of all small enterprises
were privatized
20,000 joint stock companies
established
40 million shareholders
created Advent of a wealthy
and influential class (New
Russians)
Criminal elements established
control over 50% of economy
Cash Privatization In 1995, 4,052 cash auctions
(1994-1997) conducted
In 1995 70% of budgeted
revenues were provided
through 12 loan-for shares
sales
Major enterprises privatized:
Norilsky Nickel, Sidanco Oil,
Yukos, Energy Systems of
Russia, Rostelekom, Uralmash,
Novorossiysk Shipping
Company, and Vyborg Pulp and
Paper Plant
Case-by-Case Privatization 1997: $4.2 billion
(1997-present) privatization revenues
Financial crisis of 1998
reduced 1998 privatization
revenues to $909 million
1998: Foreign direct
investment $1.5 billion
2002: Privatization revenues
expected to reach $1.19
billion
Major enterprises privatized:
Svyazinvest (25% +1 shares),
Vostsibneftgaz, Vostochnaya
Neftyanaya Kompaniya, The
Siberian-Ural Petro-Gas Oil
Co., The Tyumen Oil Co., Komi
Tek, Norsi-Oil, 2.5% of
Gasprom, and 25% of VimpelCom