SITE Working Papers

The interaction between the effects of private ownership and market competition on enterprise behavior has been a crucial unknown for policy design in transition economies. While most economists have been ready to believe that the efficiency of state-owned enterprises might be increased through both privatization to improve corporate governance and price and entry liberalization to open up competition, the implementation of privatization has faced many practical and political problems in the transition economies. As a result, privatization has proven slow and difficult, and a central debate among policymakers and analysts of transition has arisen concerning the urgency of privatization.

An important, but largely implicit, assumption in this debate concerns how the forces of competition and privatization interact. On one side of the debate are advocates of "big-bang" transition strategies, who see competition as ineffective in the absence of private ownership and effective corporate governance, which is generally supposed to be achieved through concentrated ownership by outside blockholders. During the early transition period, several economists emphasized the desirability of rapid privatization, seeing liberalization as necessary but not sufficient to inducing restructuring. At the same time, they did not favor privatization without market liberalization. According to this view, competition and privatization are complements in their effects on enterprise performance: privatization may be enhanced by more competitive markets, but competition cannot substitute for privatization.

On the other side are critics of privatization, who believe that competition can improve performance in the absence of private ownership. Given the difficulties of designing and carrying out effective privatization policies, a more cautious, "gradualist" approach is implied. According to this view, privatization and competition are substitutes, or at least independent, in their effects on firm behavior, in the sense that the marginal gain from market liberalization is not increasing with the extent of privatization. Market liberalization need not be followed up by immediate privatization, as state-owned enterprises are disciplined by the market even as they await privatization. Some advocates of the delayed privatization approach stress the need to demonopolize industry in advance of privatization, suggesting that privatized monopolists would simply raise prices in lieu of restructuring.

The substitutability or complementarity of the forces of market competition and private ownership is therefore a critical determinant of the choice of transition policy strategy. While stabilization and liberalization policies were generally introduced rapidly and with relatively little controversy (at least among most Western economists), the proper pace of privatization has become the most contested policy design issue in the transition economies. A closely related controversy has concerned the choice of privatization method. Skepticism is frequently voiced about the quality of corporate governance likely to result from employee buyouts and voucher programs, but the justification for these methods is usually couched in terms of their speed, with attention paid to design details that mitigate governance problems. Given the difficulty of carrying out trade sales to large investors, the debate is over whether such methods of privatization, even if second best, should nevertheless be a priority for policy.

In this paper, we argue that the debate suffers from two problems. First, it has been conducted on the basis of very little empirical evidence, particularly firm-level information on the interaction between privatization competition. Second, it has overlooked an important interaction at the level of the firm’s product market. We argue that the degree of competition in a market is a function not only of market structure, concentration, or the extent of price and entry liberalization but depends as well on who the participants in the market are. We hypothesize that private firms may be more aggressive competitors than state firms and thus that a firm operating in a given market may face tougher competition if most competitors are private. Thus even if the effect of privatizing a firm is independent of or substitutable for exposing it to competitive markets, privatization of competitors may be complementary, raising the effective competition associated with a particular market structure. The indirect effects of privatization, working through market competition, may be as strong as or stronger than the direct effects, which work through the corporate governance of a particular firm.

We analyze a simple Cournot competition model that distinguishes two aspects of the interaction between competition and privatization: privatization of a firm and privatization of the firm’s competitors. Under plausible conditions, the model implies that privatizing a firm is a substitute for exposing it to competitive markets but privatizing its competitors is complementary.

We then test the model empirically. Our empirical work has several distinct advantages over earlier studies of competition and firm performance in transition economies in terms of the size and coverage of the data set, the time span of observations on each firm, and the availability of a variety of measures of market structure and competition. The panel data set we use for estimation purposes is quite comprehensive, including 13,288 Russian manufacturing enterprises covering 83.3 percent of total employment in Russian industry in 1992, the year of the liberalization shock, and spanning eight years (1992–99). Since our data comprise nearly the entire population of medium-size and large industrial enterprises, including information on their exact locations and disaggregated five-digit industries, we can use much more precise measures of market structure than those available to other researchers.

We find that on average privatization improves efficiency while reduced market concentration does not. The privatization of a firm reduces the marginal impact on firm efficiency from reduced market concentration, but the privatization of its competitors increases this marginal effect. The marginal effect becomes positive when most of the firm’s competitors are privatized. It is largest when the firm’s competitors are foreign owned, although the marginal effect is still strong when the firm’s competitors are domestic firms with either private or mixed private and state ownership. The results imply that an important indirect impact of private ownership is the intensification of market competition and thus that competition only among state-owned enterprises may be ineffectual in stimulating them to increase efficiency. Privatization improves firm efficiency whether or not the firm faces competition, while reducing market concentration improves firm efficiency only if the other firms in the market are private. This evidence suggests that liberalizing the economy without also privatizing it is likely to be ineffective, that it would be better not to wait until after demonopolizing an industry to privatize its firms.

Using 1994–98 data from the Russian Longitudinal Monitoring Survey, we measure the incidence and determinants of several types of worker training and estimate the effects of training on workers’ interindustry, interfirm, and occupational mobility; their labor force transitions; and wage growth in the Russian Federation relative to the United States. We hypothesize that the shock of economic liberalization in Russia may raise the benefits of training, particularly retraining for new jobs, but uncertainty concerning the revaluation of skills may raise the costs, with an overall ambiguous effect on the amount of training undertaken. The Russian Longitudinal Monitoring Survey indicates a lower rate of formal training than studies of the United States have found, suggesting that the second effect dominates. Previous schooling is estimated to affect the probability of training positively, but the relation is much stronger for additional training in the same field than for retraining for new fields. This result is consistent with the hypothesis that schooling and training are complementary but become more substitutable in a restructuring environment. Foreign ownership of the firm also positively affects the probability of undertaking training, providing evidence of active restructuring by foreign investors. Additional training in workers’ current fields is estimated to reduce mobility and earnings, suggesting inertial programs from the pretransition era. Retraining in new fields increases all types of worker mobility and is associated with higher returns than those typically observed for training in the United States, but it also raises the variance of earnings and the probability of unemployment, consistent with a search view of such retraining. Given the large returns to retraining, the efforts of Russian workers to learn new skills may increase as uncertainty diminishes and restructuring proceeds.

Risk Factors and Predictability of Stock Returns in Central and Eastern Europe
Anete Pajuste, Stockholm School of Economics; Gatis Kepitis, Price Waterhouse; and Peter Högfeldt, Stockholm School of Economics