Privatization Conditions for the Success of Fiscal Policies

by Walter Johnson

“Privatization” in Russia and Ukraine is a bad word. From 1992 to 1998, these two economies saw the disastrous policy of privatizing many state-owned firms, especially larger ones. As this occurred, much capital fled the country, the state received little in taxes and the newly rich used their power to avoid taxes altogether. Clearly, in these two examples, privatization meant fiscal disaster. What both countries had in common in this period was the disintegration of central state power.

Fiscal Failure

Between 1992 and 1997, the ruble was devalued 80 times. By 1997, the ruble had been debased by almost 8000 percent of its Soviet era value. Ultimately, 1997 saw Russia default on its debts. A similar phenomenon was seen in Ukraine. However, in neighboring Belarus, privatization was slowed, the state remained a powerful economic player; the Belarussian economy remains strong as of the time of publication. In Ukraine and Russia, the state disintegrated during this period. Without strong central state power, privatization not only did not benefit the state at all, but created a “counter-state” at the local level that had the ability to refuse to pay taxes.

State Failure

The power of the state to regulate privatization, create a market-based legal system, and to enforce contracts remains the main condition for fiscal success. As of the time of publication, Belarus has a trade and budget surplus and low unemployment while Ukraine is still in a long and deep depression. The Belarussian state remained strong, while the Russian and Ukrainian states were captured by powerful economic elites. Because of the disintegration of Russian and Ukrainian governments, economic elites and local governments were able to pocket all proceeds of privatization. An oligarchy was created at the local level that was powerful enough to withhold taxes. Local governments, in fact, became the coercive collection agencies for oligarchs throughout Russia and Ukraine and tolerated the “private security” firms erected by the newly enfranchised oligarchy.

State Power

In 2000, the newly installed and popular president Vladimir Putin began the work of restructuring the state, centralizing power and making taxes easier to pay. In streamlining the state, instituting a 13 percent flat tax and providing amnesty for those who refused to pay taxes under the Yeltsin administration, Russian economic prospects improved, and the economy, as well as the state, grew immensely. Power was taken from the local governments on fiscal grounds -- they were no longer going to be the enforcement arm of corrupt privatization deals. The point here is that without the state capable of maintaining economic order, privatization did not mean the birth of the “free market,” but the birth of an oligarchic structure of power that took state authority into its own hands.

The Ukrainian Failure

In Ukraine, the World Bank reported that at the time of the first wave of privatizations, Ukraine had a fragmented government without accountability and a civil service that was loyal to whoever paid them the most. A strong professional bureaucracy backed by state power is necessary to translate privatization into fiscal success. This includes independent courts and a law code that stresses equity and fairness in tort cases involving shares of privatized firms. The World Bank also recommends that a strong, state-controlled budget is necessary. In the early 1990s, these budgets were haphazard, ad hoc, and did not include or report large segments of state spending. Since the state was fragmented, so was the budget.


Photo Credits

  • Jupiterimages/ Images