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Privatization Concept

Mass Privatization is the "mass" sale (i.e. a large number of enterprises sold rapidly) to a "mass" number of investors (employees and the public) of a large percentage of shares (25% to 100% of each enterprise) in exchange for privatization "certificates" distributed free-of-charge to all citizens. In Ukraine, Mass Privatization involves the universe of the country’s approximately 10,000 medium and large industrial enterprises and the distribution (to date) of certificates to 90% of Ukraine’s 50 million citizens.

The most common general criticisms of Mass Privatization are that "certificate privatization has produced no positive results", i.e. that

  • no significant revenues have been generated for the state budget"
  • "privatization of the largest enterprises has not really begun,"
  • "effective new owners have not been created"
  • "strategic investors have not appeared"
  • "no financial improvements have appeared at the enterprise level".

    Mass Privatization Objectives versus Cash Sales Objectives

    Among many Ukrainian officials and citizens, there is confusion between the objectives of mass privatizaton (accelerated political transformation of the economy) and the objectives of cash sales (revenue generation for the national budget and for capital investment in industry). Many officials believe that mass privatization and cash privatization are two separate and contradictory forms of share sales. In fact, they are closely related and are complementary.

    Government of Ukraine’s Objectives for Mass Privatization

    In 1994, the Vice Prime Minister and the Minister of Economy, on behalf of the government of Ukraine, and officials of the World Bank, the United States Agency for International Development and the European Union, on behalf of the international donors, signed a Memorandum of Understanding to govern Ukraine’s mass privatization program. This set forth the commitments of the government of Ukraine to implement the mass privatization program and the commitments of the international donors to provide technical and financial assistance for the program.

    In the Memorandum, the government of Ukraine agreed to the following general objectives for the mass privatization program:

  • The objective of mass privatization in Ukraine is to (1) distribute shares rapidly and equitably to the citizens of Ukraine, (2) develop capital markets and capital market infrastructure and (3) rapidly create a critical mass of privately owned enterprises to allow necessary restructuring and modernization to proceed under the direction of the new private owners." (The Memorandum also states that "many other economic factors - external to mass privatization - are critical to the success of the privatization program and privatized enterprises. Progress regarding these factors must occur in parallel to mass privatization.")

    The government of Ukraine’s decision in late 1994 to begin a mass privatization program was based on a realistic assessment of the country’s situation and on a general vision among Ukraine’s leaders as to the path of reform to be pursued:

  • state-ownership, state management and official corruption had resulted in political mismanagement of the country’s resources and the eventual collapse of the Soviet economy,
  • "privatization" of Ukraine’s industry, as practiced in the early 1990’s (prior to the mass privatization program), had been in the form of "spontaneous" privatization whereby the nomenklatura was involved in the widespread appropriation of state assets,
  • recovery and growth would require radical new initiatives to create an environment which encourages competition, investment and risk-taking by the private sector while discouraging official corruption,
  • and that Ukraine’s future lies in a liberal, market economy with expanding ties to new markets in Europe and other regions of the world.

    Ukraine’s reformers also realized that accelerated economic reform and the completion of a mass privatization program would require, more than anything else, a high degree of political will on their part. In other words, Ukraine’s leaders would be required to fight an on-going political battle with those parties most interested in maintaining the status quo or increasing the role of the state in the economy.

    Opposition to mass privatization appeared (and continues to appear) from many different constituencies:

  • tate-owned enterprise managers, bureaucrats in the branch ministries, and politicians who did not want to lose their privileges and control over state assets;
  • reactionary politicians who had yet to realize that it would be impossible to "turn back the clock" to a state-owned/command economy;
  • "entrepreneurs" who had reaped large and questionable profits from their business connections and cooperation with political leaders and state-owned enterprise directors;
  • and older citizens and the most vulnerable segments of the population who realized that they might lose their jobs, that they did not have the skills to compete in a market economy and that the government was unlikely to provide sufficient social welfare benefits to sustain them during the transition to a market economy.

    Why "Mass Privatization"?

    Based upon the experience of other countries which had earlier initiated the transition to a market economy, Ukraine’s reformers understood that mass privatization offered the only opportunity for rapid, broad-based, in-depth structural reforms of the economy.

    With sufficient political will by leaders at the highest levels of the government, Ukraine’s reformers understood that implementation of a mass privatization program could succeed in producing such structural reforms because:

  • Mass privatization, with the participation of millions of enterprise employees and millions of citizens, is the most transparent, efficient and rapid means of transferring control rights over the assets and cash flows of Ukraine’s industry from the government to the private sector. The accelerated transfer of the ownership of Ukraine’s economy from the state to the private sector is the single most important objective (and result) of mass privatization.
  • The basic assumption behind this objective is that government/political ownership of industry results in unproductive, uneconomical, non-market oriented, corrupt, and "political" management of industry - and ultimately to industrial mismanagement and industrial decline. Mass privatization is the single most rapid and efficient means of "depoliticizing" ownership of the economy. There is nothing more important to the success of Ukraine’s reforms.
  • As government ownership and management of industry disappears, new, private sector investors - who are willing to accept the risk of losing their capital in exchange for potential returns, are encouraged to become enterprise owners. Not only do such new owners invest their capital, they work hard to ensure a maximum return on their investment. And a maximum return requires that these new owners replace existing, often incompetent (and often corrupt) directors, restructure production by expanding those most profitable and promising business lines while discontinuing unprofitable business lines, develop new marketing strategies and new markets for their products, retrain employees, create enterprises better able to compete in both the domestic and international markets and enhance share value for their shareholders.
  • With ownership transfer from the state to the private sector and with new owners and managers of formerly state-owned enterprises, conditions are created for the government to play a new role in the economy: not as an owner of industry but as a regulator to promote an optimal environment for the development and growth of the private sector, for the promotion of entrepreneurship by the public, for the rule of law over property rights and business contracts, for the encouragement of investment through a reduction in both bureaucratic interference with business and onerous taxation, and for the creation of a general climate in which government promotes rather than discourages the private sector.
  • Workers, managers, the public and financial investors will actively respond to economic incentives and opportunities - as provided through the mass privatization program - to become shareholders in their own enterprises, in attractive enterprises with which they are familiar and in enterprises which they believe might best prosper in a market economy.
  • Mass privatization (preferential share sales to employees and public certificate auctions) of the shares of Ukraine’s largest and most attractive enterprises is the most effective, rapid and transparent means by which privatization of such enterprises is initiated and by which employees and managers (and the public) become long-term investors in and supporters of the privatization and restructuring of their own enterprises. Mass privatization is the first stage in the privatization of large, attractive enterprises and provides a base of employee and broad, public shareholder support for major new shareholders and owners - i.e., financial investors who purchase shares in cash auctions and strategic investors who acquire majority shareholdings through cash/investment tenders. Thus, mass privatization is not incompatible with cash sales and tenders but, in fact, serves as the basis for successful future cash sales and the attraction of new capital investment by strategic investors.
  • Mass privatization is one of the most transparent, competitive and accelerated forms of privatization with shares sold on an objective basis to bidders offering the highest number of certificates. The process of selling shares through the mass privatization program is therefore the ideal model for sales of shares for cash and via tenders for strategic investors. Transparent and competitive procedures for cash sales and investment tenders are an effective means of attracting domestic and international financial and strategic investors to Ukraine’s privatization program. It is therefore critical that Ukraine’s sales of remaining large or majority share packages in its strategic enterprises employ the transparency and the non-subjective, competitive and accelerated aspects of the mass privatization program (while avoiding non-transparent, uncompetitive and time-consuming forms of privatization such as "non-commercial" tenders and case-by-case/negotiated share sales).
  • The final major reason behind the government of Ukraine’s decision to implement the mass privatization program in early 1995 was the understanding by government reformers that the rapid and broad distribution of shares to millions of new shareholders quickly creates improving conditions for:
  • the development of a large and active secondary securites market for the trading of shares in privatized (as well as newly established, privately owned) enterprises,
  • the acquisition of large shareholdings in Ukraine’s promising privatized enterprises by strategic and financial investors who provide new investment in plant and equipment and who exercise their shareholder voting rights to initiate changes in management, production, marketing programs, training and utilization of employees, and other strategies which will generate long-term, sustainable growth and profitability for such enterprises in a competitive, market economy,
  • the liquidation of uncompetitive, unpromising and bankrupt enterprises and the redeployment of their assets to more productive and profitable uses,
  • the ability of promising enterprises - which have been restructured by their new, private sector owners - to pay wages and benefits to their employees, to pay their electric bills, to pay taxes and, in general, to serve as financial contributors to their workers, their communities and the government,
  • and the ability of the government, with increased tax revenues from expanding and profitable enterprises and with reductions in state subsidies to industry, to utilize scarce state budget revenues to support the most vulnerable segments of society: workers who are temporarily unemployed as a result of the bankruptcy and liquidation of enterprises, pensioners, and those who are unable to care for themselves.

    In practice of course, privatization is always a "messy," complicated and very political process. The benefits of enterprise restructuring and the inflow of new investment capital do not occur immediately after privatization. The tangible benefits of privatization depend to a great extent upon the government’s (with the active participation of the private sector) ability to create a supportive environment for the growth and expansion of the private sector, e.g. less bureaucracy, reduced tax burdens, a transparent and equitable regulatory regime, land privatization, the protection of investor and shareholder rights, the rule of law. At the same time, experience proves that, if the leadership of Ukraine focuses on rapidly accomplishing the objectives of mass privatization while addressing the "environmental" issues, new investment, enterprise restructuring, and the revival and growth of Ukraine’s economy will follow.

    Price Waterhouse/USAID Ukraine Mass Privatization Project

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