MAXIM BOYCKO Russian Privatization Center ANDREI SHLEIFER Harvard University ROBERT W. VISHNY University of Chicago PrivatizingRussia WHENANATOLY B. CHUBAIS was put in chargeof the State Committee on the Managementof State Property(GKI) in October 1991,privatiza- tion was not at the top of Russia's reformagenda. Price liberalization and controlof the budgetwere the top priorities.Politicians and the pub- lic debatedwhether Russia shouldbe privatizingat all before macroeco- nomic problems are solved. No privatizationprogram existed at the time. In fact, the very name of Chubais' agency reflected the govern- ment's ambivalenceabout privatization. A year and a half later, privatizationhas become the most successful reformin Russia. By September1993, more than 20 percent of Russian industrialworkers were employedby privatizedfirms. Privatization has spreadeven more widely in service firms. More than 60 percent of the Russianpeople supportedprivatization, and Chubaishas become one of the betterknown politicians. [Mostof the datain this paperexist in an unpublishedform in Russianagencies, where they were collectedby the authors.The authorstook care to ensureaccurate transcription of the datain this paper,but it has not been possibleto verifythe dataas is usuallydone in the courseof editingthe paper.-Eds.] DavidFischer and Florencio Lopez-de-Silanes provided excellent research assistance. Some of the resultsreported in this paperuse surveysconducted by JosephBlasi and Ka- tharinaPistor for the StateCommittee on the Managementof StateProperty. We aregrate- ful to StanleyFischer and Jeffrey D. Sachs for theircomments at the BrookingsPanel. 139 140 Brookings Paper-s on Economic Activity, 2:1993 In this paper,we try to describeand evaluate the progressof Russian privatization.Doing so at this point raises the obvious problemof tim- ing. Privatizationin Russia is extremely young. What has been accom- plishedis largelya formaltransfer of ownershipof cash flow and control rights of some firms from the state to private parties. Real changes in the operationsof enterpriseshave barely begun. We cannot, therefore, evaluate the progress of Russian privatizationbased on the actual im- provementsin efficiencyit has delivered.Instead, we need to use a more subjectiveyardstick to evaluate the accomplishmentsof privatization, namely our educated estimate of the likelihood that privatizationwill lead to restructuringof privatizedfirms. We arguethat the key prerequi- site for restructuringis depoliticizationof firms, meaninga change in their conduct from meeting the wishes of politicians to maximizing profits.In this paper, we try to evaluate whetherprivatization in Russia is in fact depoliticizingstate firms. The second section presents our case for looking at depoliticization to predictrestructuring success. We arguethat, in most countries,politi- cians try to influencefirms to pursue political objectives, such as over- hiringor locatingin particularareas. Firms' managersextract subsidies from the treasuryin returnfor addressingthese politicalgoals. The re- sult of this politicizationof firmsis inefficiencyin publicenterprises. We arguethat privatizationis just one of several steps that makeit more ex- pensive for politiciansto influencefirms. As such, privatizationreduces the amountof inefficiencythat firmsaccept to satisfy politicians, but it does not make firms fully efficient. Creatingproduct marketcompeti- tion, improvingcorporate governance, and eliminatingpolitical control of capital allocationare other importantsteps that make political influ- ence more expensive. An importantmessage of the second section is that debates about whetherprivatization, corporatization, or any other single measureis sufficientto make firmsefficient miss the point: these are all partialmeasures of depoliticization. In the thirdsection, we discuss the designof the Russianprivatization programin lightof the objectiveof depoliticization.In particular,we dis- cuss why Russia opted for voucher privatization,rather than for a Pol- ish-style mutualfund scheme. We also show that, quite aside from its objectives, the Russianprogram was to a largeextent shapedby the po- litical constraintson what was feasible. Maxim Boycko, Andr-ei Shleifer, and Rober-t W. Vishny 141 The fourth section presents the basic facts about Russian privatiza- tion, includingsome evidence on its extraordinaryspeed. We also ad- dress an importantpuzzle that the evidence raises, namely the remark- ably low valuationof Russianfirms in the marketplace. In the fifth, sixth, and seventh sections, we look beyond privatization and ask what other mechanismscan reduce politicalinfluence on firms. The fifth section briefly describes the disnial state of product market competitionin Russia. The sixth section examines governanceof firms throughequity ownership. We presentsome surveyevidence suggesting that privatizationin Russia is leading to very significantownership by managersand workers,and some ownershipby largeoutside sharehold- ers. Whilesome managementand outsiderownership is a cause for opti- mism, the extent of insider entrenchmentraises concerns about future restructuring.In the seventh section, we turnto depoliticizationof capi- tal supply mechanisms as a step toward depoliticizationof firms. We firstdescribe the currentcapital allocation mechanisms in Russia, which are still primarilypolitical and dominatedby the financingpractices of the government and the central bank. Commercialbanks are playing only a minorrole in capitalallocation. We also describe the role of mac- roeconomic stabilizationand of foreignaid in depoliticizingcapital allo- cationin Russia. The evidence in the sixth and seventh sections suggests that, in the nearfuture, if capitalallocation is to contributeto depolitici- zation of firms,it shouldavoid the highlypoliticized commercial banks. The eighth section presents some evidence on the politicaleffects of Russian privatization.In particular,we include results suggestingthat privatizationmay have helped PresidentBoris Yeltsin to win the crucial April25 referendum,in which the Russianpeople endorsedhim and the reforms.We conclude in the ninth section by summarizingour findings. The Goals of Privatization To focus on the goals of privatization,it is useful to start by asking what is wrongwith publicenterprises and why. On the questionof what is wrong, there is much agreement:public enterprises are inefficient. They employ too many people, produce goods that consumers do not want, locate in economicallyinefficient places, do not upgradetheir cap- 142 Brookings Paper-s on Economic Activity, 2:1993 ital stock, and so on. While these problems are particularlysevere in easternEurope, public enterprisesthroughout the world are conspicu- ous for theirinefficiency, as well. ' This observationis no longercontro- versial. The questionof why public enterprisesare inefficientis harderto an- swer. Standardpublic finance starts with the assumptionthat govern- ments maximize social welfare, and views public enterprisesfrom this vantagepoint. In particular,public enterprisesare supposedly produc- tively efficient, and in fact cure monopoly and externality problems caused by privatefirms.2 As a positive theory of public enterprises,this one fails miserably.More recent work has stayed with the assumption of benevolentgovernment, but arguedthat publicenterprises are ineffi- cient because the governmentis poorly informedabout their efficiency, and so rationallysubsidizes them to pursue uncertainprojects.3 These theories mightexplain why governmentssubsidize highly uncertainre- searchand developmentprojects or defense contracts.It does not, how- ever, make much sense as an explanationof the dramaticinefficiency of publicagriculture, coal mining,and other relativelyroutine production. The highcosts and inefficienciesof such firmsare publicknowledge, yet the governmentstill does not insist on theirrestructuring. An alternativetheory of public enterpriseargues that they are ineffi- cient because they become the means by which politiciansattain their politicalobjectives.4 Excess employment,location in economicallyinef- ficientplaces, and underpricingof outputall help politiciansget votes or avoid riots. For example, it is plausibleto arguethat the principalobjec- tive of the Russiancommunists was to secure theirown survivalagainst (perceived)external and internalthreats. Manyfeatures of the commu- nist economy follow from this assumption. Russian state enterprises producedso manymilitary goods because the politicianscared about se- curityand not about social welfare. The governmentlavished capitalon militaryfirms at the expense of consumerproduct firms for the same rea- son. The communistgovernment invested resources in public health, but not in healthcare for the elderly, because it needed healthy soldiers, 1. Mueller(1989) and Vining and Boardman(1992) survey the evidence on the relative efficiencyof publicand privatefirms. 2. Atkinsonand Stiglitz(1980). 3. Laffontand Tirole (1993) and Dewatripontand Maskin(1990). 4. A versionof this theoryis presentedin Boycko, Shleifer,and Vishny (1993a). Maxim Boycko, And)rei Shleifer, and Rober-t W. Vishny 143 not because it was humanitarian.The communist government asked firms to overemploy people because it insisted on full employment to prevent social unrest that would threatenits control. The government createdlarge collective farms to control peasants and so avoid the per- ceived threatfrom them. State firmsproduced large farm machineryto ensure that only