Re-privatization Should Be Avoided

Article in Kyiv Post

February 2, 2006

Re-privatization is ultimately bad for economic growth despite the politics that surround the issue.
Summing up the economic results of 2005, one indicator strikes you: Economic growth in Ukraine plummeted from 12.1 percent in 2004 to 2.4 percent in 2005. Was this huge decline real? President Viktor Yushchenko has argued that the growth in 2004 was greatly exaggerated by virtue of previous doctoring of foreign trade statistics. Exports were exaggerated in order to extract fraudulent value-added tax (VAT) refunds, while large imports entered through the free economic zones, little havens of tax evasion.

As the argument goes, some 3 percentage points of the growth in 2004 should be deducted to 9 percent, which means that the growth in 2005 might have been 5.4 percent. Some adjustment is probably justified. Even if the decline in growth rate was "only" 4 percentage points, it is palpable. But from January till August 2005, official GDP growth for each month year-on-year fell by approximately 1 percent a month, from a growth of 6.5 percent in January to a slump of 2.7 percent in August. The slump was concentrated in a few sectors: investment, construction, metallurgy, and machine building. It would be easy to assume that external factors were decisive, but this is not plausible. Average world steel prices were significantly higher in 2005 than in 2004.

While world energy prices rose, Ukraine benefited from low gas prices from Russia, which provided the lion's share of Ukraine's energy. Indeed, the inventory was run down contrary to what is typical at the end of a boom. The predominant causes of the decline were domestic economic policies. Ukraine was hit by three negative policies-the re-privatization debate, a sharp increase in the overall tax burden (probably from 36 percent of GDP in 2004 to 42 percent of GDP in 2005), and erratic state manipulation of prices and trade for gas, meat, and grain until August.

For many reasons, the re-privatization debate seems the all-dominant blow to the Ukrainian economy. The decline was highly concentrated to those sectors most vulnerable to re-privatization-metallurgy and heavy machine building. These companies swiftly minimized their investment. Food processing, agriculture, consumer goods production, retail trade, banking, and even real estate kept expanding fast because of substantial increases in salaries and social transfers. Naturally, Ukrainian businessmen who were most exposed to re-privatization adopted a defensive posture, focusing on legal defense of their property and holding back on both investment and production. Other big businessmen eyeballed specific disputed properties.

Therefore, they hoarded cash and invested less than previously planned in their companies. Overall, Ukraine ended up in a wait-and-see situation. From 2000 to 2004, Ukraine underwent a wonderful economic revitalization, and as everywhere else in the postcommunist world, the only thing that really worked was private enterprise. Mass privatization did the trick in Ukraine. To demand nationalization today, as some politicians actually do, is to call for renewed economic decline. It does not help if the state buys good private companies at market prices as is currently happening in Russia.

Their productivity inevitability falls in the corrupt hand of the state, explaining why Russia's industrial output grew by merely 4 percent in 2005 in spite of the energy price boom. But, purported advocates of justice have been crying foul, calling for a review of Ukraine's corrupt privatizations. Is justice worth fighting for? Well, the courts are the main channel through which such wrongs would be challenged, and they are pervasively corrupt.

Presumably, they are far more corrupt today than when the original privatizations were undertaken, and it takes a long time to cleanse corruption. As a result, it would be reasonable to expect re-privatizations to be more corrupt than initial privatizations. Look upon the party lists for the parliamentary elections. All of them, also the parties favoring re-privatization, contain numerous prominent businessmen.

What are the objectives of those businessmen? Clearly, they want to cheaply seize the properties of less well-connected competitors. Many rave about just privatization, forgetting that literally every person has his or her own conception of the term. Some emphasize original property rights or inheritance; others labor, tenants' rights, economic efficiency, state revenues, equality, or need.

But the concept of a perfect privatization remains a utopian impossibility. The proponents of re-privatizations argue that almost no re-privatization was actually carried out. The mere debate causes sufficient damage. A sharp decline in economic growth means that the welfare of the country does not develop as was possible, and that is a serious matter if we think that Ukraine's main economic problem is poverty.

To say that economic welfare does not matter is nothing but irresponsible populism. Many suggest that the auction of Kryvorizhstal was a successful re-privatization, because the state received $4.8 billion rather than $800 million. To compare, just look at Russian oil company Yukos. In 1995, its main parts were sold to Menatep for $310 million.

By 2003 the company was worth $45 billion thanks to restructuring. In 1995, nobody could contemplate anybody paying more than $5 billion for this loss-making, criminalized company. But by 2000, Yukos paid more than $5 billion a year in taxes. Is not foreign ownership good? Not necessarily. Foreign direct investment is often beneficial, but least of all in big Soviet industry, because foreign investors rarely know how to work with the authorities; they are reluctant to downsize these overstaffed enterprises; they do not know how to combat the frequent criminalization at old state enterprises; they do not understand the old technology or organization but tend to gut the factories and install expensive new equipment.

Locals are usually better at dealing with these issues. After the purportedly successful re-privatization of Kryvorizhstal, Nikopol Ferroalloy Plant was nationalized for no legal reason whatsoever, only because the former prime minister capriciously so desired. To nobody's surprise, the Ukrainian legal system failed to defend the lawful owner's property rights, and the government sees nothing that it can do. If re-privatization had not been broached, the Ukrainian government would not have defaulted so badly on property rights. The fundamental truth, which the Peruvian economist Hernando de Soto has spelt out in his book The Mystery of Capital, is that "capitalism triumphs in the West and fails everywhere else."

The reason is that the West long ago learned to respect property rights regardless of their origins, while most of the developing world has so far failed to do so. The question today is whether Ukraine will join the West or the third world. The critical issue is whether the nation accepts property rights or not. Countries that did not have never become wealthy.