The government plans to reform the system
of public property management and launch a wide scale sell-off. Are Ukraine’s economy and
society ready?
For more than a
year, Ukraine has been debating about what, how and when should be privatized.
It has not yet gotten as far as organizing actual tenders to sell large
state-owned enterprises, but preparations for privatization are underway. This
generates various rumors and myths that distort public opinion on
privatization.
The process is
more important than the result
More than a year
ago, Prime Minister Arseniy Yatsenyuk announced "the largest privatization
in 23 years." Nothing much happened over this year: privatization proceeds
amounted to mere USD 467 million. Still, the process has been launched, and even
advanced from empty talks to practical steps. In the recent months, the
government went as far as organizing privatization tenders.
The government has
done a lot in this time. The Ministry of Economic Development and Trade (MEDT)
prepared Ukraine’s Top-100 State-Owned Enterprises, a review report compiled
jointly with PriceWaterhouseCoopers, Dragon Capital, the Soros Foundation and
the Government of the United Kingdom, that is likely to catch investors’
attention. This is the first report of the kind providing comprehensive
analysis of the position and growth prospects for a hundred largest state-owned
companies (accounting for over 90% of total income of all state-owned
enterprises in Ukraine). The Ministry plans to publish such reports quarterly
and annually, following the practices of more advanced countries. The report
also looks at the best practices in public property management in member-states
of the Organisation for Economic Co-operation and Development (OECD). Guided by
international experience, the report announces the reform of state-owned
enterprises. The ultimate goal is to increase their efficiency and make them
more competitive on the market.
Public property
reform suggests a number of interesting initiatives. One is to increase
transparency in the operation of state-owned enterprises through a mandatory
requirement to prepare their financial statements in accordance with
international standards and to do audits by independent international agencies.
In addition to that, the focus of state-owned enterprises is expected to shift
to generating profit. This will be done through segregation of business
operation and other functions – social or political – state-owned enterprises
often carried out earlier. An example is Ukrzalisnytsia, Ukrainian state
railway carrier that provides discounts for some social categories. The same
goes for the separation of powers in ministries: they are currently both
regulators and owners of the enterprises. This leads to a conflict of interests
and distorts incentives that could otherwise come from the markets.
Finally, the
crucial component of the reform is mandatory establishment of independent
supervisory boards. They will appoint members of management boards and decide
on business development strategies.
Previously,
state-owned enterprises operated in two ways. One was for oligarchs, being
minority shareholder de jure, to control managers. Thanks to good contacts in
the government they preserved that status quo for years, while channeling
company cash flows to their accounts (Ukrnafta, Ukraine’s biggest state-owned
oil extraction company operating on local oil fields, is the most recent
example, but there are dozens more). The other scenario was for the managers to
deliver suitcases full of cash to those at the helm, and in case of a power
shift, to those "newly-elected". This would grant them a carte
blanche to leave some cash for themselves (Ukrspyrt, the monopolist producer of
alcohol further used in the production of alcoholic beverages, is probably the
most well-known case). Under any of these “business models” state enterprises
brought to the budget – and to Ukrainian taxpayers – mere pennies or, worse,
losses, while the parasites rushed to grab as much as possible before a new
change in government. This is bound to change after the current reform. Every
state-owned enterprise will have its own supervisory board comprised of
government representatives as well as independent experts (who may even
outnumber the officials). This will stop excessive government meddling and the
practice of being run by oligarchs de facto. Coupled with decent financial
reward for the supervisory and management board members (the Ministry of
Economy proposes a wage hike), this should make the operations of state-owned
companies more efficient in the near future. They will then show improved cash
flows which will guarantee real market price in privatization. For natural
monopolies or strategic enterprises, privatization should not be an option.
Besides the
report, the government has completed a lot of organizational work. Most
importantly, Ihor Bilous was appointed head of the State Property Fund of
Ukraine (SPF), filling the post that remained vacant for almost a year. The
Cabinet decided to put up for privatization in 2015 a list of over 300
state-owned enterprises (majority and smaller stakes), including many large
ones. The 2015 budget expects USD 17bn in privatization proceeds. All these
principles of transformations and mechanisms to implement them have become part
of the public property reform strategy and the relevant legislation amendments.
A list of a dozen
companies that are top priorities for privatization is being compiled; the
action plan on five of them is already in place and waits to be approved by the
end of September. An inter-agency work group is to be set up to monitor and
eliminate embezzlement at state enterprises. It is also expected to conduct
independent audits of at least 100 largest enterprises, propose amendments to
the legislation in order to increase wages for the managers, and develop a plan
to restructure companies that pose the biggest risks of losses to be covered
from the national budget.
Obviously, the
preparations for large-scale privatization are well under way in compliance
with the best international standards. There is political will for
privatization, and it seems to be supported from the overseas. Actually, this
will is so overwhelming that some believe the only significant function of
Yatsenyuk as Premier to be "selling everything that has not been
sold." According to Mr. Bilous, the first facility, Odessa Port Plant
(OPP), will be set for an auction in November or December. Rumor has it that
Norwegian, American, Arab and Ukrainian investors have already expressed their
interest. It is yet to be seen whether no efforts are taken to restrict access
to the auctions for bidders, and whether this interests translates into a
decent price for the OPP.
Today, the
barriers significantly hampering the privatization process are plenty. Most
importantly, the oligarchs are doing everything in their power to prevent
privatization, since they stand no chance of winning transparent privatization
tenders (the value of the companies for them is clearly lower than for foreign
investors, because they will never manage to make them as efficient). This
resistance is cited among the reasons for the dragged-out preparation of
Tsentrenergo, a major supplier that generates 8% of electricity in Ukraine, for
privatization. And just days before this article went to press, Premier
Yatsenyuk postponed privatization of the Odesa Port Plant. The official reason
– a need to change evaluation methods for state-owned facilities – caused
rumors of his playing into the hands of oligarchs.
The judiciary
poses another barrier. Recently, the infamous Kyiv Commercial Court deemed
illegal the privatization of 25% of Dniproenergo, another major electricity
supplier with Rinat Akhmetov’s DTEK as a major shareholder. This actually means
re-privatization. More similar lawsuits may delay the privatization process for
months.
State capitalism
in the world
In theory,
privatization is undoubtedly necessary, since the state cannot be an efficient
business owner. In practice, the concept has its pros and cons.
On the one hand,
massive waves of privatization held in most countries in 1970–1990's are
evidence in its favor. Privatized companies became more efficient and more
capable of growth. Still, state-owned enterprises play a major role in many
economies throughout the world today. These are the countries of state
capitalism.
China, and less so
other Asian countries, is a model of economy with successful and effective
state companies. This is due to a number of specific features. One is mentality
that puts national interests before private ones and prevents state company
executives from filling their own pockets. Another one is severe punishment for
corruption, ranging from huge fines to death penalty. Each year, about 100,000
corruptionists are caught in China (and their criminal cases do not get stuck
at the Prosecutor's Office or the courts, as is the case in Ukraine), and
thousands of them are sentenced to death. The third feature is the polished
legislative environment with high standards of corporate governance, preventing
officials from interfering with companies' work or pocketing parts of their
cash flows. Of course, China, like any other country with state capitalism,
uses state-owned enterprises for more purposes than profit making alone, but
even these alternative purposes focus mainly on economic growth priorities that
feed the economy.
In other countries
of state capitalism, the performance of state corporations is far less
impressive. Firstly, most state-owned companies there generate a much lower
profit margin than their private-owned competitors. The market price of their
shares always includes a discount for the low quality of their corporate
governance, something that is unavoidable in a company with the state as the
owner. Secondly, state-owned enterprises are reluctant to develop. Therefore
they are virtually absent from most innovative industries. Thirdly, they appear
in frequent corruption scandals. Facts of massive corruption related to the
state gas giant Petrobras have recently surfaced in Brazil: private construction
companies (and not only them) bribed government officials to get contracts from
this state monopolist. The scandal involved the ruling party members, including
President Dilma Rousseff. The losses of this state corporation today are
estimated at USD 16bn. As long as state capitalism exists, such incidents will
take place regularly.
In Russia, state
capitalism has degraded further. State banks have monopolized the financial
sector (which, by the way, made them a convenient target for Western sanctions),
accumulating the bulk of financial resources and lending them to state
companies. This environment hampers the development of either private banks or
producers with limited access to financial resources. State oil and gas players
squeeze private companies out of the market thanks to monopoly access to the
best fields and transportation infrastructure. Add to that opportunities to
seize the assets of private businesses – the swallowing of Yukos by Rosneft is
one example. Heads of state corporations and corrupt officials have formed an
intricate net where one hand washes another. Operating in the environment of
impunity and complete lack of self-criticism, this has brought Russia to the
blind alley of civilization. Its state-owned companies are focused not on doing
business, but on financing Russia’s geopolitical interests, as seen by the
Kremlin. Such form of state capitalism is the most vicious, and is completely
at odds with business efficiency. Worst of all, state corporations in Ukraine
were until recently following the Russian model. This requires drastic and
radical change. If Ukraine is to embark on the path of development, it cannot
afford to have state capitalism of the Russian kind.
Public property, Ukrainian style
According to the
Ministry of Economy, Ukraine has 3,374 state-owned enterprises as of today.
This is almost double the figures in 28 out of 34 OECD countries (except for
the United States, Turkey and several small countries). Only 1,920 out of them
are operating. The question is: what happened to the rest, and what were the
management methods used by the state and its officials that led to this? Total
assets of all state-owned enterprises were worth USD 813bn, or almost 52% of
Ukraine’s GDP, as of mid-2014. Cumulatively, they generated losses even before
the Maidan. In 2014, their financial performance deteriorated further.
Total
mismanagement of state corporations surfaces not only in journalist
investigations that reveal corruption and abuse by state company executives,
but also in mere facts and figures. Statistics give solid proof that public
assets should be restructured to make them work effectively as a minimum, and
privatized as a maximum. As seen by an average Ukrainian, the money the state
collects (in the form of increased taxes or utility tariffs) is much more
important than the money the state fails to receive because it was stolen by
officials with a little help from state company managers. Yet, these losses
amount to tens of billions of hryvnia. If they ended up in the budget (or were
used to develop the companies and create jobs), the actual level of social
benefits could be much higher than it is now.
Statistics dispel
the myth about preserving the status quo as the best strategy for public
property management. Firstly, what good are the assets that generate no cash
flow? Secondly, what happened to the companies that went out of operation? The
answer is simple: their equipment was used as scrap metal, stolen or taken
away, and the buildings were rented out for kickbacks. All of this happens with
the consent of the officials who transfer part of their income from this
"up the chain." The longer the companies remain state-owned without
reform and restructuring, the more they will be pilfered, increasing the burden
on the budget. It is obvious that civil society should in no way tolerate this
status quo.
Enchained by
preconceptions
There are many
other widespread myths related to privatization. The government should take
seriously the issue of dispelling them by commenting on the process and on its
outcomes.
The main myth is
that after the privatization, companies will work worse. The best case to the
contrary is ArcelorMittal Kryviy Rih (former Kryvorizhstal). In 2005, when the
company was privatized following an open tender that remains unique to this
day, it had 55,400 employees earning an average of 1,522 hryvnia per month,
which was 89% higher than the average salary in Ukraine. Its net income was
UAH11 bn, or USD 2.15bn. 10 years after the privatization, in 2014, the company
had 28,800 employees (the ones that were laid off received huge compensations)
with the average monthly salary of UAH 6,661, which is 91% more than the
national average. Its net income increased by half to UAH 36.7bn, or USD
3.09bn. At the same time, over the 10 years from 2005 to 2014, the company
invested USD 12bn, increasing almost six times its average annual investment
from less than UAH 200mn before the privatization to UAH 1.2bn thereafter.
ArcelorMittal
Kryviy Rih is a typical example of a successfully and transparently privatized
company that improves its efficiency and increases production, while reducing
staff and paying higher wages. The salaries of the company's employees could
well have been higher, but that would hardly be a feasible option for the
owners in a situation where there are armies of the unemployed willing to work
for less.
Companies
privatized non-transparently have fewer reasons to be proud. Ukrtelecom, the
nationwide fixed line operator, faced a "grabitization" in early
2011. In 2011–2014, it reduced its staff by 31%, and payroll by 12%. In this
way, the average salary increased by 29% compared to a 55% increase nationwide.
Its net income fell 4% even in UAH terms. Annual investment dropped by several
times, from UAH 0.7–1.7bn before privatization to UAH 0.15–0.65bn thereafter.
DTEK Zakhidenergo
PJSC, grabitized by Rinat Akhmetov in the late 2011, is in a slightly better
situation. In 2012–2014, its staff was reduced by 23% and payroll by 2%;
however, its net revenue in hryvnia terms increased by 58%, and annual
investment grew by several times, from UAH 100–150mn to UAH 400mn.
Quite often,
state-owned enterprises begin to perform more poorly after falling into the
hands of oligarchs through privatization. The workforce is hit the hardest: the
only thing that the oligarchs manage to do under any circumstances is to lay
off staff, and reduce salaries to get more benefit for themselves.
Development and justified profitable investment are above their head.
Therefore, those who believe that state-owned enterprises should not be
privatized because they will work worse are right to a certain extent. However,
the cause of possible deterioration is not privatization as such, but
privatization that is obscure and noncompetitive, inaccessible to efficient
private bidders. With a competitive and transparent tender, the result will be
quite the opposite. The lone example of ArcelorMittal Kryviy Rih is the proof.
Another common
misconception is that when a company is state-owned, it "feeds" many
employees, who now and then sell stolen goods, spare parts etc. After the
privatization, however, the new owner will quickly stop this petty trade by its
personnel, thus impoverishing the population. There are several aspects to
this. First of all, Ukrainians got used to stealing state property (at
collective farms, state farms, and factories) back in the Soviet days. But back
then, we fleeced a foreign country, while now it is our own. Therefore, this
habit should be thoroughly eradicated. If privatization can remedy this, then
it should be done as quickly and fully as possible. A state where theft and
corruption are a social convention cannot develop. This has been taught by the
greatest minds of the mankind since ancient times, and has been confirmed by
practice.
Secondly,
privatization does deprive many people of opportunities to make money, and
therefore – to survive, even if illegally, in the Ukrainian economy (in
addition to hordes of petty traders of stolen goods, privatization will
generate another horde of laid-off workers, as well as officials who lose their
shadow income). Therefore, comprehensive economic reform should be carried out
in parallel with privatization in order to improve business climate and foster
new businesses that could absorb vacant workforce and give people the
opportunity to make money. Only in this case will privatization be socially
effective and contribute to the country's development. Otherwise, its only
noticeable implication for society will be increased unemployment, social tensions,
and emigration. Ukrainians have had enough of all these problems.
A careful analysis
of the advantages and disadvantages of privatization on the basis of theory,
international practices and local specifics shows that Ukraine really needs
one. The phase of restructuring state-owned enterprises and preparing them for
tenders is especially important. Coupled with the fact that, in times of war,
the sale of state corporations is one of the few available sources of budget
replenishment and foreign exchange earnings through FDI, it shows the dire need
for privatization. Whether the current government manages to get the message
across to the public and avoid social tensions caused by privatization by
improving the business climate remains to be seen.
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