Several East European countries are now expanding their private sectors by encouraging new firm formation and privatizing much of their present state sectors. In Discussion Paper No. 544, Research Affiliates Irena Grosfeld and Paul Hare first note that creating a market environment in Eastern Europe will require major legal and institutional changes, while privatization requires decisions on the scope and speed of the programme, the preferred method(s) of transferring ownership, eligibility conditions for new owners, arrangements for restitution of property to former owners in some cases, and the management of the residual state sector. Rapid privatization accompanied by substantial restructuring and unemployment will also require social protection policies.

Grosfeld and Hare assess Czechoslovak, Hungarian and Polish experience to date and review the three countries' plans for 1991-3. The programmes these countries announced in late 1990/early 1991, which aim to privatize half their state sectors by 1994, comprise `small' and `large' privatization. `Small privatization' the sale or auction of small businesses such as shops, restaurants and small manufacturing firms to existing managers or new owners should be substantially complete within two years. `Large privatization' the transfer to private ownership of the large state firms that still account for the overwhelming bulk of productive capacity will be achieved by a variety of methods. Hungary will sell its firms to single buyers or through public share offerings; while Czechoslovakia and Poland will also give their citizens substantial fractions of the shares in their largest firms. The Hungarian government expects a substantial inflow of funds to the state budget, but it also believes that free distribution of shares fails to address the problem of improving management performance. Czechoslovakia and Poland have designed their voucher schemes to ensure that at least part of each firm's share capital will form concentrated holdings to facilitate proper supervision by shareholders. Both approaches entail problems, since slow sales may be required to maintain a `reasonable' share price; while distributing shares free involves considerable administrative complexity.

Grosfeld and Hare also note that these economies' rapid transitions to the market economy entail major difficulties in the valuation of assets and developing the financial markets in which the privatized firms' shares may be traded. Many firms now have loans which they cannot service under market conditions, while the banks are carrying substantial bad debt, so the balance sheets of both must be restructured if they are to function effectively. Finally, the management of the residual state has received remarkably little attention, although it is clear that productivity gains within the state sector may make a substantial contribution to Eastern Europe's economic performance at least until the mid-1990s.

Privatization in Hungary, Poland and CzechoslovakiaIrena Grosfeld and Paul Hare

Discussion Paper No. 544, April 1991 (IT)