The Process of Privatisation
5. A brief comment on the first phase of privatisation
Self-management was a peculiar ownership structure in which the bundle of property rights was split between workers’ collectives and public bodies that usually represented local communities; the Communist Party, its interests and ideology strongly influenced the decisions of these public bodies. It appeared that self-management was not adequate for the organization of the business activities of a developed economy that was to be exposed to international competition. From the end of the 1960s the management class fought for changes of the property regime.21 Since the functioning of the financial system was heavily distorted, the
individualisation of the rights to residual income and their transferability were proposed. Throughout this work I will follow the destiny of the management class during the transition from socialism and the development of the financial system. The first phase of privatisation in Croatia (and in Slovenia) was an initial allocation of shares (property rights to residual income). Dispersed shareholding is a form of collective ownership but of a different kind to workers’ cooperative. Shareholders’ voting rights are differently distributed from employees’ voting rights; in the case of shareholding the right to a residual income is transferable, while in the case of workers’ cooperatives this transferability is usually restricted.
5.1 Costs and attributes
After the initial distribution, shareholders in Croatia encountered the problem of how to utilise their legal rights. The costs of organization of business activities under the new circumstances emerged. I have identified several
20 In the case of Zagrebacka banka a court case concerning an initial investment of 100 euros, which
was rejected by the Bank as not valid, after a 15 year long trial was concluded with the judgement that the Bank must pay around 20 million euros (Rajić 2004 – “A boy from Knežija inherited 60 millions”; ‘A boy from Knezija’ implies the member of mafia). In another case, the president of the second biggest bank was beaten with a baseball bat, presumably because he didn’t accept that the Bank should pay 10 million of euros in respect of allegedly falsified ownership (Jelinić 2002)
21 Croatian sociologist Josip Zupanov (1983) developed the idea that the alliance between the
Communist Party and the working class was blocking the modernization of the society and the innovative ideas of those excluded from that alliance (the intellectuals, the management class).
groups that fought for resources: the old and the new management class; workers; clients of the ruling party (war veterans and invalids, war victims and their families, former political prisoners); the Diaspora and foreign investors. The competitors were oriented towards different attributes of the resources: the interest of workers was predominantly how to retain employment; clients of the ruling party were oriented to drawing money from assets; strategic investors (Diaspora and foreigners) were oriented to seizing control over a company, since the capital market was undeveloped and exit was difficult and expensive; the new and the old management fought to stabilize their executive positions and power. Though all these groups held shares, their starting positions were different. The old managers enjoyed an informational advantage and established relations with business partners and creditors; however they were blamed for belonging to the old system. This latter characteristic they shared with employees as far as the exercising of property rights was concerned. The new managers enjoyed the support of the new ruling party and they were usually ready to undertake radical restructuring, as were the strategic investors.
5.2 The struggle and alliances
The traditional understanding that basically distinguishes public and private ownership without taking into account inherited business relations and routines, nor the influence of ideology and public opinion, i.e. social institutions that create incentives and constraints on the use of property rights, cannot adequately capture what then took place.22
In a number of companies, workers and management established alliances; in the beginning it appeared to be a winning combination. Often it was the old management which won the support of workers23. However, smart new owners and
new executives appointed by the new ruling elite were in some cases successful in
22 The taking into account of tradition, customs, ideology, theoretical expectations and other
social institutions one may consider a trivial truism that doesn’t affect the traditional approach to property significantly. This understanding assumes that social institutions only slightly disturb the workings of a private property economy. I do not think that this is correct. The idea that we have to pay attention to market institutions confirms a fundamental insight that ownership is costly; that economic property rights, which assume capturing of income flow, should be distinguished from legal property rights. Chapter II and III analyse theoretical distinctions between the two approaches.
23 Food producing companies Frank and Vindija, tourist companies in Istria, and machine producing
making an alliance with the employees.24 Much more often the conflicting groups
struggled for control over resources that eventually led to their dissipation (see the interpretation of Luek’s analysis of initial appropriation in chapter II, section 4.4). The intervention of the government was frequently welcomed as putting an end to the destructive fight between conflicting sides. The arbitrary activities of the government were eased due to the absence of democratic tradition.
5.3 Decrease of the value of resource
The strategies of enforcement of property rights that were used by the old and the new management may be better understood following the insights and analyses provided by Douglas W. Allen (2002). According to Allen, an owner sometimes decreases the value of a resource under his control for the purpose of deterring a possible competitor. The decrease of the value of a resource increases the relative costs of taking over the resource assuming that the costs of the taking over are constant. Various tactics were used: as mentioned above, the executives sometimes intentionally decreased the assessment of the value of a company; tunneling (asset stripping) was described in chapter V; resources were overused. Low transparency of business was also a tactic to avoid predators. The executives (mostly the old ones) formed alliances with friendly bankers and converted a banking loan into equity, although it wasn’t necessary; it decreased the percentage of the equity available for takeovers and secured support from the banker. These phenomena confirm how costly property rights are, both their protection and their exercise.25
These phenomena confirm Allen’s insight that the relationship between the value of resource and the delineation of property rights is not necessarily linear; a better enforcement of property rights doesn’t imply an increase of the value of a resource.
5.4 The purpose of the administrative chaos
I would like to comment briefly on two features that were described above: the administrative chaos and the relationship between the authoritarian government and property rights. Administrative chaos has been a common feature of several countries in transition and the subject of several pieces of
24 Food processing companies Ledo, Zvijezda and Dukat were taken over by the allies of the new
ruling party but their employees were very satisfied with the new owners.
25 Allen (2002, p. 341) understands the costs of establishing and maintaining of property rights
over an asset as “all costs of ownership, whether they are enforcement, measurement, moral hazard, or other such costs.” Allen emphasises that transaction costs cannot be reduced to the costs of exchange.
research. Allen’s (2002, p. 354) explanation that a hidden goal of American and Australian penal colonies was to discourage possible French and Dutch claims to the territory is here suggestive: “penal colonies lowered the value of the colony and made it less attractive to foreign aggressive powers”. By analogy, the administrative chaos in countries of transition increased the costs of the use of property rights and lowered the value of assets. For those people who quickly got control over the resource the chaos wasn’t a problem, but an opportunity. The uncertainty about when the rule of law would be established led them to choose an economic strategy of asset-stripping at the expense of other property owners (or the overuse of resources) instead of building the value of the resource; that gave them an interest the postponing the establishment of the rule of law. As a consequence, the assumption that a distribution of property rights would increase the demand for the rule of law appeared to be incorrect (for further arguments see Hoff & Stiglitz 2005).
As was expected, costly enforcement of property rights de-stimulates investment in fixed capital. In such circumstances, according to North (1990), small private companies remain small, while larger companies, although private, go under the protection of the state.26 As a consequence, costly enforcement of property rights
influences the tendency for the size of company to decrease, except for those companies that are under the government’s umbrella. That pattern might be seen in Croatia. The distinction between private and governmental ownership blurs. The so-called agreement economy, which was the last phase of self-management (chapter IV) “was characterised by the tetragonal: company – local community – bank – Party Committee.” (PPEED 1001, p. 13) 3 High costs of enforcement of
property rights after the first phase of privatisation, re-established relations of almost the same character as had existed before: company – community (local, regional, national) headed by the ruling party – bank. It is concluded that under the transition, clientistic and predatory state re-emerged (Franicevic 2002). Following Libecap (cf. my chapter III above), in circumstances of an unbridgeable disagreement about the distribution of assets, the problem might be resolved by a side-payment to one of the parties in the conflict. The transfer of assets to
26 “With insecure property rights, poorly enforced laws, barriers to entry, and monopolistic
restrictions, the profit maximising firms will tend to have short time horizons and little fixed capital, and will tend to be small scale. The most profitable business may be in trade, redistributive activities, or the black market. Large firms with substantial fixed capital will exist only under the umbrella of government protection, with subsidies, tariff protection, and payoffs to the polity – a mixture hardly conductive to productive efficiency.” (North 1990, chapter 8)
preferred groups, workers, war veterans, former political prisoners etc., can be interpreted as side payments, though it stimulated the growth of a client’ state. As a consequence, the first phase of the process of privatisation in Croatia did not confirm the hypothesis that private property stimulates the development of a liberal democracy, which was a central postulate of the programs of transition in Croatia and a standard component of a number of scholarly papers that promoted privatisation (see for example Vojnic 1991, p. 89).27 Secondary privatization,
which is the subject of the next chapter, describes the development of a market, particularly the development of a financial market in circumstances of the costly enforcement of property rights.