At a Brussels joint lunchtime meeting with the European Centre for Advanced Research in Economics on 7 May, Gérard Roland and Paul Seabright presented the results of recent research on privatization in Eastern Europe. Roland is Professor of Economics at the Université Libre de Bruxelles, Co-Director of ECARE's research programme on Eastern Europe, and a Research Fellow in CEPR's International Macroeconomics programme. His remarks were based in part on his CEPR Discussion Paper No. 699 (with Patrick Bolton), `The Economics of Mass Privatization: Czechoslovakia, Germany, Hungary, Poland', to appear in issue 15 of Economic Policy, October 1992. Seabright is Fellow and Director of Studies in Economics at Churchill College, Cambridge, and a Research Fellow in CEPR's Applied Microeconomics programme. His remarks were based on his CEPR Discussion Paper No. 640 (with Ken Mayhew), `Incentives and the Management of Enterprises in Economic Transition: Capital Markets Are Not Enough'. The meeting formed part of CEPR's research programme on Economic Transformation in Eastern Europe, supported by the Commission of the European Communities under its SPES programme and by the Ford Foundation. The views expressed by the speakers were their own, however, not those of the above organizations nor of CEPR, which takes no institutional policy positions.

Roland noted that Czechoslovakia, (East) Germany, Hungary and Poland have all freed most prices and adopted similar tools for macroeconomic management but have differed significantly in the design and timing of privatization. This has proceeded slowly: despite important successes with shops and small businesses, privatization of larger enterprises once expected to be complete within three years still remains in its initial stages. Roland argued that mass give-aways of shares in state firms are undesirable, since they lead to budgetary crises, unleash inflation and may destabilize the new and fragile democratic regimes. They also unduly favour incumbent managers: with neither well-functioning capital markets nor the discipline of product market competition, inefficient managers will not easily be removed through take-overs so long as the monopolistic structure of the old state sector remains in place. Financial intermediaries are intended to play a supervisory role in Poland; but their effectiveness in controlling incumbent managers remains unclear.

Roland advocated selling state assets through auctions, which efficiently allocate resources when sellers do not know which buyer can make the best use of the asset, while individual bids also provide valuable information to potential future private investors. Such sales also provide revenue to governments at the point in the transition when taxation poses the greatest difficulties, although the flow of savings cannot quickly absorb the massive stocks of state assets. Roland recommended allowing both cash and non-cash bids in such auctions, so that the low level of private savings need not slow privatization in order to raise revenues. Even wealth-constrained buyers can participate in such auctions, if governments allow them to borrow on the basis of their future revenues from the privatized assets. Non-cash bids will achieve greater productive efficiency, since bidders' willingness to pay will reflect their ability to run the newly acquired firms profitably, while also reducing the temptation for governments to spend privatization revenues immediately.

Privatization by auction also enables governments to write off enterprises' existing debts without substantial revenue loss, since the write-offs are reflected in higher bids, but important difficulties will remain. The monitoring efforts required to identify serious buyers will inevitably slow privatization, while the larger firms will see a separation of ownership and control, so the newly privatized banks or supervisory boards of the German type may need to supervise their managements. Roland noted in conclusion that East European governments face increasing difficulties in tax collection, even in the remaining state sector, which privatization will exacerbate; these countries should therefore concentrate on maximizing privatization revenues as a top priority.

Seabright agreed with Roland's emphasis on the importance of non- cash bids in ensuring the efficient management of privatized firms and argued that restructuring proposals are effectively a type of non-cash bid. He went on to discuss the criteria by which such restructuring proposals should be evaluated, stressing in particular the danger of relying on capital market competition in the post-privatization phase. This can do much to improve efficiency, but reform is needed elsewhere to curb managers' pursuit of their own interests and to represent adequately the interests of other stakeholders whose commitment is essential to the firms' efficient long-run management. Stock markets contribute significantly to efficient asset bundling and to monitoring, but excessive reliance on them may have damaging effects. The development of a banking system as the supplier of capital and operator of a credible bankruptcy mechanism is at least equally important. Regulatory restrictions that segment the financial system make little sense: the same parties may hold multiple classes of financial contract, and banks in particular may benefit from holding equity stakes.

Workers' interests must be adequately represented if they are to undertake the necessary long-term investments in effort, training and wage restraint; formal representation on supervisory boards on the German model may diminish their day-to-day interference in management and increase their strategic influence, which are both desirable. Managerial inefficiency can easily become entrenched despite pressures from capital, labour and product markets, however, if fragmentation of ownership reduces owners' ability to act coherently or even to devise efficient incentive schemes for their managers. East European governments should therefore devise corporate constitutions for their enterprises and implement effective internal incentive mechanisms before they are privatized.