THE BACK DOOR: SPONTANEOUS PRIVATIZATION IN HUNGARY

THE BACK DOOR: SPONTANEOUSPRIVATIZATION IN HUNGARY*

by

Imre BRANYICZKI, Gyula BAKACSI

Department of Management and Organization

Budapest University of Economics

and

Jone L. PEARCE

Graduate School of Management

University of California, Irvine

The political changes that have swept Hungary in the past fewyears have been truly revolutionary. However, its newly elected gov-emment has not begun comparably sweeping economic transforma-tions through privatization. When the state has played such a domi-nating role in the economy, privatization of state-owned companiesmust be the centerpiece to any substantial economic reform (Komai,forthcoming; Stark, 1990; Tardos, 1989), and yet govemmental pri-vatization programs have not moved rapidly in any of the formerly

communist countries. We hope to provide a picture ofprivatization in

Hungary in the 1989-1991 period, as it has been experienced by

managers and employees in enterprises undergoing privatization.While there are numerous excellent institutional analyses of Hungarianprivatization (e.g., Kornai, 1990; Stark, 1990), we hope that this briefdescription of participants' organizational behavior can provide addi-tional insights into these complex institutional changes. In particular.

* This research has been supported by the Hungarian Business EconomicsScientific Society and a University of California, Irvine Faculty Fellowship.

304 I. BRANYICZKI, G. BAKACSI & J.L. PEARCE

our research with our small sample of companies indicates that in theseenterprises (1) there is little substantive distinction between "formal"or centrally-directed privatization and "informal" or spontaneousprivatizations save that the formal privatizations have been delayed;(2) the combination of circumstances has led these managers andemployees to welcome foreign ownership and direction; and (3) theHungarian economy is rapidly privatizing despite the slow pace offormal govemmental privatization programs.

The enterprise descriptions are drawn from a longitudinal studyof economic transformation begun by the three authors late in 1989(when the American team member was a visiting professor at theInternational Management Center in Budapest). A sample of sixenterprises which represented the three msyor forms of ownership inJanuary 1990 (state-owned companies, a joint venture between aHungarian state-owned company and a West European business, andtwo entrepreneurial companies) was selected. Data collection consistsof unstructured and structured interviews, employee questionnaires,and company archival data. Fortunately, all three of these sampledstate-owned enterprises were selected to participate in th e government'sfirst formal privatization (FPP) program which began in 1990. (Only 20Hungarian state-owned companies are beingprivatizedin this program.)Therefore, we had the opportunity to become familiar with theseorganizations before their formal privatizations began and have beenable to study the process in some detail at the company level.

Because terms such as privatization and spontaneous privatiza-tion have been used broadly in the debates over these processes, wemust begin by clearly defining these concepts for this analysis. By"privatization", we mean the transfer of part or all ofthe ownership ofa company to a private profit-seeking person or institution. In Hungary,many state-owned enterprises are changing their legal structure byconverting to nominally independent satellites (KFT) or shareholdingcompanies (RT) which remain wholly owned by the state or stateenterprises. For the purposes of this work, a company is considered tobe "privatized" only when a significant proportion is owned by non-state profit-seeking companies or individuals.

Similarly "spontaneous privatization" has entered the politicaldebate, and it has often become a code word for transactions in whichenterprise managers use their positions to construct privatizationagreements that provide an unfair personal benefit to themselves -through arranging bank loans for their own purchase of companyshares or through contracts with new owners that protect them from

THE BACK DOOR: SPONTANEOUS PRIVATIZATION IN HUNGARY 305

dismissal. What is Tair" under these circumstances can become a verycomplex and ideologically charged question - one which we would liketo leave in the political arena. Fortunately, the cases of spontaneousprivatization describehereprovidedno ownership or jobprotectionsforanyone in the enterprises. It i s better to describe these cases, and manysimilar ones, as company-initiated rather as than centrally- directed.We believe that a few well-publicized scandals have tainted a mannerofprivatization that differs, our research suggests, from formal pri-vatization only in its speed.

Before presenting these cases it is necessary to provide a very briefdescription of Hungarian privatization in early 1991. We then describethe managerial and employee organizational behavior in two sampledenterprises that are participating in the government's first formalprivatization program. Next, we provide two illustrations of manager-initiated privatization.

1 Privatization in Hungary

Within Hungary, there is abroad consensus that privatization (insome form) is needed both to increase international economic com-petitiveness and to attract foreign capital. The efficiency of Hungarianstate-owned companies is generally very low: they are characterized bywasteful production, over employment, and poor quality marketingand management (Markoczy, 1990; Pearce, Branyiczki, & Bakacsi,1991). In Hungary, privatization serves another vital national objec-tive. Hungary has high internal and external debts, and, because theeconomy is struggling from the collapse ofthe Eastern Bloc markets,there is little income for debt reduction. Income from the privatizationof previously nationalized companies and properties will be used by thegovemment to pay its debts. Despite such ui^ency, rapid privatizationwould place a potentially large proportion of the economy in foreignhands - politically an unpopular outcome. Another difficulty facingprograms of formal privatization is the inertia inherent in largebureaucracies (Mintzberg, 1979). Many newly elected officials preferthat the state be intrusive, just as it has been for the last forty years.The election was perceived by many as just a change of players. Despitetheir much publicized intentions, many members ofthe bureaucracystill encourage the expansion of bureaucracy.

From the government's point of view, rapid privatization by salesto foreigners is a panacea to help cure many of the problems of the


economy. Managers of state-owned companies also consider privatiza-tion a panacea, but for them, it is a cure for different problems,including the lack of cash, diminishing markets, and the need fortechnological development. Many companies consider privatization aredemption or, at least, a source of free investment capital. Becauseprivatization holds great promise, the government is pursuing sales toforeigners through its formal privatization programs (FPP) and jointventures. However, it does so nervously and slowly.

The State Property Agency (SPA) was established by Law VII. 1990for the purpose of helping and controlling the privatization ofthe stateowned companies. Spontaneous privatizations generated a great dealof debate by late 1989, and the SPA was created, in part, to bring theseprivatizations "under central control". Thus, the SPA itself has con-tradictory roles - aiding privatization and limiting privatizations thatare not in the interests ofthe state. Hungary's first formal privatizationprogram (FPP) includes 20 companies and began in September 1990with an announcement ofthe companies to be privatized. An invitationwas extended to private consulting companies to "bid" for the privati-zation contracts for each company. A bid was to include the plan forprivatization (whether the company would be sold to someone else,whether shares would be offered to the public, plans for companymanagement during the transition, etc.).

2 Centrally-Directed Privatization in Practice

2.1 Company-initiated centrally-directed privatization: The case ofthe Sheet Glass Company

The Sheet Glass Company produces drawn glass for a wide varietyof industrial and consumer goods companies and has almost twothousand employees. Until the Soviet market collapsed in 1990, it wasprofitable, one ofthe most successful companies in a northern indus-trial region of Hungary. Since a lar^e proportion of the company'sproducts were built into goods for Soviet export, the sudden loss of thatlarge market in 1990 caused a serious liquidity crisis. In the meantime,an expensive new investment had just been completed to improve thecompany's heat- treated special-glass technology. Only with the help oftwo Hungarian banks did the company avoid bankruptcy in 1990.

To the managers of this company, it seemed vital that an injectionof cash and new markets for their products be found, and privatization


seemed to be the optimal solution. The company has substantialcapacity to produce marketable goods, so foreign companies from theglass business showed an early interest and began to investigate thepossibilities of forming a joint venture or of buying the company. Thatis, this company was actively seeking "spontaneous privatization"many months before the FPP began.

While discussions with possible foreign joint-venture partnerswere progressing in mid-1990, another crisis struck: the recentlyretired managing director was charged with misusing company re-sources. The top management was replaced, and an investigation ofthecompany began. This delayed progress in the negotiations with foreignpartners.

Within a few months during 1990, the Sheet Glass Companyreceived three major blows: the loss of large part of its market, seriousliquidity problems, and an investigation of company fraud. Theseproblems demanded much of the new managers' time and causedserious morale problems in the work force. Within this six-monthperiod, production had to be reduced and almost 20 percent of theworkers were laid off. These circumstances placed the company in analmost hopeless situation, at the brink of collapse. So, the managementgroup decided to apply for participation in the FPP.

The application was accepted by SPA because the company hadhad some previous negotiations with possible foreign investors. Noagreement hadbeen reached with these investors because the previousmanagers had been afVaid their names would be associated with large-scale layoffs following a joint venture with private owners and theydidn't want to deal with the resultant regional outcry. Also, because thecompany was almost bankmpt, the foreign investor had wanted to buyit for a much lower price than its estimated book value. If the managershad sold the company for such a low price, they would have beensuspected of bribery or of trying to keep their positions. The firstprivatization program of SPA served the managers very well: theycould pass the responsibility for the consequences ofthe privatizationto the consulting company and the SPA.

When the SPA opened a tender for consulting and investingagencies to manage the procedures ofthe privatization ofthe listed 20companies in late 1990, more than ten agencies sent bids for theprivatization of the Sheet Glass Company. The SPA made the finalselection in December 1990. The bid proposed that part ofthe companybe sold to a large multinational glass manufacturing holding company


based in Westem Europe. While the govemment will keep a certainproportion of the shares, that amount has not yet been determined.Unfortunately, delays at the SPA meant that the company still had notbeen privatized by February 1992. The frustrated foreign companydecided to make a substantial investment in Czechoslovakia instead ofin the Sheet Glass Company. The company had to conduct anotherlarge layoff in 1991, and the loan payments on the previous invest-ments (equal to total labor costs in 1991) have brought the company tothe edge of bankruptcy.

The participants' reactions to these events within the companyplace them roughly into two groups. The first group consists ofthe verysmall number of top managers and associated professionals who havebeen involved in negotiations with possible foreign partners, SPAofficials and consulting companies. Because of the need to speakforeign languages, younger professionals with this capability haverisen very rapidly in importance. Further, their exposure to negotia-tions with foreigners (and their ability to take advantage of proliferatingmanagement education programs) have led them to learn a great dealabout capitalist approaches to company evaluation and markets in ashort period of time. They are excited, optimistic, and very overworked.In contrast, the rest of the managers and the vast mcyority of theemployees are frightened and passive. They witnessed the layoffs andknow that the company has severe liquidity problems; they know thatthere are extensive negotiations with ministerial officials and foreigners,but they do not really understand what it all means. Their perspectivesare still dominated by "old system thinking" (e.g., complaints that thegovernment doesn't give them enough money to buy better technology).The company has already lost numerous professional employees whofeel more secure in foreign joint ventures.

2.2 Government-initiated centrally-directed privatization: The caseofthe Porcelain Factory

The Porcelain Factory makes fine tableware, figurines and other"collectibles". It was founded by an aristocrat in 1777 on his remoteestate near the Slovakian border. This was a "self-governingcompany",which meant that it was governed by an enterprise council in whichemployees elect 51% ofthe members, until its conversion to an RT inlate 1991. The council was the highest authority within the company;it could hire and fire all managers and make the strategic decisions.

The Porcelain Factory also faced a collapsed market in 1990.Eighty percent of this company's saleshad been domestic, and, with the


decline ofthe Hungarian economy, the demand for porcelain goods haddecreased much more than the demand for basic goods. The companyhad distributed through state-owned stores and a few of their ownshops, so their marketing and the sales activities were under-developed.They are able to produce quality goods which are internationallymarketable, but by late 1990 they had a large stock of unsold inventoriesand a severe liquidity problem.

Prior to participation in the FPP, the Porcelain Factory had haddiscussions with an interested foreign partner from (then) West Ger-many. However, the investmentbank intermediary dropped the projectfor reasons unknown to the management. The attractiveness of theirproducts and prior foreign contacts were the reasons why a repre-sentative ofthe SPA contacted the company proposing participation inthe FPP at an enterprise council meeting. Concurrently, by the secondhalf of 1990, the company management decided to enter a companytransformation program financed by the European Economic Com-munity. The program was directed by a Dutch con suiting company, andits primary aim was to address problems related to the company'soperations, marketing, and sales activities. The group was to seekpotential foreign partners who could provide distribution channels andinvestment capital. At the enterprise council meeting, the representativeof SPA argued that the best interests ofthe company would be servedby its joining the FPP, since any subsequent partnership would haveto be approved by the SPA. The SPA could prevent the company fromproceedingindependently. Therefore, the council voted to take part "bytheir own will" in the FPP instead of pursuing their previous programwith the Dutch consulting company.

After the formal announcement of participation, 17 bids weremade to privatize the Porcelain Factory. An intemational investmentbanking consortium was chosen by the SPA. This group's proposal is totransform the company into a shareholder company with the SPAowning 100 percent. Then, the consulting company plans to issue aninformation bookletforpossibleoutside investors. Alocal governmentalauthority currently holds a minority interest, but its proportion ofthefinal shares has not been decided. By February 1992 the company hadnot yet been privatized and had not taken the steps necessary todevelop a marketing capability. It continues to lose money in thedepressed Hungarian retail market.

The reactions ofthe employees in this company are complex. Thisis the only employer of any size within 25 kilometers, so the town istruly a company town. Many current employees are the children and

310 I. BRANYICZKI, G. BAKACSI & J.L. PEAHCE

grandchildren of former employees. In addition, numerous employeesare very specialized (e.g., hand painters of porcelain), and comparablehousing would be impossible for them to find elsewhere in the country.Thus, the labor force is not mobile, and numerous personal tragedieswould result if employees lost their jobs. Their fear is refiected in theenterprise council's firing, in June 1990, of the previous managingdirector when he proposed trimming managerial positions. To date,there have been no layoffs, yet the growing stockpile of unsold goodsworries these highly dependent employees. They are well aware thattheir current and previous managers have not proactively marketedthe company's products. These employees have developed a belief thatforeigners will "save" them. For example, in December 1990, while wewere conducting interviews at the factory, the announcement wasmade ofthe selection ofthe consulting company which would developthe privatization plan. Many employees were jubilant that "they hadnew foreign owners" who would now begin to market their products inthe West. Only a few of the top managers clearly understood thecomplex relationships among the various agencies and organizationsinvolved in the privatization.

2.3 Centrally-directed privatization in formerly communistcountries

Both of these cases of formal privatization illustrate two featuresof this process that may extend to other companies and countries. First,early privatization (in the form of joint ventures) was initially resistedby these companies' managers because they feared the political outcrythat would follow restructuring and the attendant layoffs. Eventually,however, it had become undisputably clear to these employees thatgoods being produced were not moving out of warehouses and that neworders were not arriving. The devastating economic collapse of 1990and 1991 has changed the political environment. By late 1990, theseemployees and manners knew that their govemment could not con-tinue to rescue them. Further, they had seen employees' salaries atjoint ventures and private companies double and triple. Layoffs werehappening with or without privatization, and privatization offered thechance to save some jobs as well as to increase wages. While there arestill some state-owned companies in Hungary with managers who donot want joint-ventures or ownership transfers to foreigners, they havedwindled to a minority.

Second, the creation of an additional bureaucratic entity, the SPA,has helped to blur responsibility for the consequences ofprivatization.


For any FPP privatization, four different entities are involved: theofficial "owner" (the Ministry of Industry), the SPA (which organizestheprocedure for privatization), theprivateconsultingcompany (whichwill manage the privatization), and the company management (whichis involved in the strategies for managing the transition). If any groupof employees tries to exert pressure for favorable treatment, wherewould they start? Any entity that is the target of influence can claimthat it is not responsible. It is particularly important to note that theorganization most likely to take public responsibility for any negativeconsequences would be the consulting company - usually with acomplex foreign joint-ownership, which makes it less subject to politicalpressure.

3 Company-Initiated Privatization in Practice

Despite the fact that the Hungarian govemment has not yetformally privatized an industrial company, there has been substantialprivatization over the last several years. Such privatization can takemany different forms. For example, many small professional organi-zations, such as training companies and advertising agencies, havebecome partnerships of their members; in effect, the govemment"gave" these organizations to their professional employees. Such pri-vatization is difficult to track and happens outside the publicitygenerated by the FPP, so few people know the entire scope and rangeof all ofthe forms of company-initiated privatization. However, we willfocus on two ofthe forms that may be less well known to outsiders yethave important implications for the economy as a whole. These are 1)joint ventures between foreign partners and state-owned companiesand 2) "employee entrepreneurism" in which state-owned companyemployees go into business for themselves, often in direct competitionwith the state companies and while still remaining as their employees.

3.1 Joint-venture privatization: The case ofthe Elevator Company

The Elevator Company is a large company which designs, installsand services elevators and has about 40 percent ofthe market for theseproducts and services in Hungary. Until the late 1980s, the companywas part of a very large industrial combine which was running debtsthat were an enormous drain on the government's treasury (due toother companies within the combine). Afler mounting financial crises(and, possibly, personal confiicts), the govemment broke the combineinto separate companies, prorating the debt among all of them. Thus,


the Elevator Company came into existence in the late 1980s as anenterprise which had a sound core business but a very large inheriteddebt.

In an attempt to solve its desperate financial problems, in early1989 top management began to consider joint ventures with a foreigninvestor. Discussion began with the West European firm with whichthe company had a licensing agreement. However, a rival multina-tional elevator company also showed interest in investing in theElevator Company. When a report ofthe rival's proposal appeared inthe newspaper, the licensing company made an even more attractivecounter offer.

The licensing company's proposal was chosen over the proposal ofthe other multinational elevator firm because it offered greater im-provement in technology and more complete services to customers. Inaddition, the management felt that its fifteen-year association with thelicensing company would provide an easier transition. Managementsigned the letter of intent with the Hcensing company in 1989, and thefinal agreement was signed in early 1990.

The joint venture has a complex structure. The West Europeancompany own 75 percent, and the original state-owned elevator com-pany, 25 percent. The foreign partner contributed several hundredmillion HUF, but the money stayed within the company to invest inbusiness and technological development. As part ofthe agreement, thestate-owned company transferred all of its business to the joint ventureand agreed not to compete with it. The joint venture then rented spacefrom the state-owned company and hired its best employees. Only ahandful of employees remained with the state-owned company, whichnow does small contract assignments for the joint venture and acts asa landlord. Thus, the large state-owned company is essentially an"empty shell" which owns buildings and a minority stake in its formerbusiness.

The Elevator Company was one ofthe first large companies to beprivatized in Hungary, which had an important effect on the employ-ees' attitude toward the proposal. In 1989 the Soviet market had not yetcollapsed and few non-specialists realized the extent ofthe wrenchingchanges that would accompany economic conversion. The joint ventureproposal called for a reduction in the workforce from about 720 to 450employees (in both the joint venture and the remaining state company).The management ofthe Elevator Company had numerous emotionallycharged meetings with representatives ofthe trade unions. Finally,


due in part to the persistence ofthe top managers, they were able topersuade the trade union that the gains for the remaining workers(significantly higher salaries, better equipment and working condi-tions, and training in Westem Europe every other year) outweighedthe costs to those laid off. Ultimately, through the use of early retire-ments, only 100 of the original employees were laid off.

During these transition years, the managers and most employeesofthe company went through formal and informal programs to learnthe standard managerial practices ofthe foreign partner. Many havespent time working in sister plants in Westem Europe. By 1992, theiroperations, information systems, performance standards and financialand accounting record-keeping systems had to be transformed to makethem compatible with those ofthe new partner.

With the cash and capital injection which came from the foreigninvestor, the new joint venture is in a good position in several respects.The joint venture is implementing state of the art technologies inconducting research and is using the management procedures oftheforeign partner. It has added new services and products. The state-owned holding company is happy with the solution, since more than ahundred people are supported through renting out its state properties.The employees ofthe new joint venture received large wage raises andbetter technical and working conditions. Despite the severe recessionof 1990-91, the company has retained its market share and hopes togrow rapidly when the economy improves.

3.2 Employee entrepreneurism: The case ofthe ComputerCompany

This example ofprivatization is the most informal and the leastvisible in Hungary. Yet, we consider it to be a form ofprivatization,since state-owned companies are using their resources to provide thefinancial base that allows employees to begin their own businesses.This practice is widespread and involves skilled emplo3rees at everylevel, such as carpenters who work privately at "second jobs'* andEnglish professors who translate for foreigners' business negotiations,and so on. While these practices are common in developed capitalistcountries, what is unique in Hungary (and, we suspect, in other formerand reforming communist countries) is that the state-owned "primaryemployer" allows the skilled employee a great deal of latitude toconduct private business "on company time". It is an arrangement thatbenefits both parties. The state-owned employer (actually, the imme-diate supervisor) can retain a valued employee who would otherwise


leave a shamefully underpaid position. The employee can earn a livingand start a business that may become very profitable while retainingthe security of his or her primary employment. Because incomes haveremained at subsistence levels for so many years in Hungary, fewwould-be entrepreneurs have savings that can be used to launchbusinesses. In some cases, such as the one described below, the stateemployer, in actuality, is a founding "investor" in new companies.

A large Hungarian state-owned computer company had for manyyears been the monopoly provider of certain kinds of computer servicesfor other companies and cooperatives. The economic liberalization inthe 1980s came at the same time as the technological revolution inmicrocomputers and sophisticated off-the-shelf software. Some state-owned companies and cooperatives began to compete with the ComputerCompany in certain markets, and many employees lefl to form theirown companies which installed microcomputers and often providedbetter service than this (former) monopoly. Thus, the company facedtwin crises of unfamiliar competition and an accelerating loss of someof its most skilled employees.

In the regional offices, several local directors tried to solve theimmediate problem of employee fiight by coaxing would-be entrepre-neurs to remain with the company. In some cases, they even purchasedmicrocomputers from their own employee-entrepreneurs. While thissolution met the immediate needs ofthe parties, it did take potentialbusiness away from the Computer Company and often lefl "competi-tors" in the awkward position of providing strategic advice to theirstate-owned employer-competitor. With the present turmoil about thestrategic direction of computer companies, these particular individualscan have a large infiuence on the state-owned competitor-employer'spolicies. Thus, the immediate supervisor is solving his or her currentneed for skilled employees in a way that could potentially underminethe long-term viability ofthe state-owned company by funding potentialcompetitors and by allowing them to infiuence the company's policies.

3.3 Company-initiated privatization in formerly communistcountries

Centrally-directed privatization is only a small component oftheactual privatization occurring in Hungary and, we suspect, in someother formerly communist countries. As company managing directorsare allowed more freedom, many naturally tum toward foreign com-panies which have the distribution channels, advanced technology,and capital that these companies desperately need. Although govern-


ments may wish to restrict and control this company-initiated sponta-neous privatization because they feel the companies are being sold "toocheap" (or more likely, because they want ttie capital for their owntreasury), central control has simply added delays which have exac-erbated the problems of the two state-owned companies in the FPPdescribed above. Of these three privatizing companies, only the"spontaneously privatized" one has actually received foreign capitaland training. By February 1992, nearly 18 months after being selectedforthisshowcaseprogram,neitherofthe other two had been privatized.

Central direction of such a complex process simply presentsoverwhelming information processing and political limitations that, inpractice, has virtually paralyzed this form ofprivatization in Hungary.In company-initiated privatization those individuals who have theinformation (and the incentive) for privatization can proceed with thecomplex negotiations and analyses necessary to complete the work. Itseems to be no accident that the vast amount of foreign investment informerly communist countries is goingto Hungary. There the departingcommunists began spontaneous privatization in order to provide jobsfor themselves; however, they began a process that has made privateinvestment easier. A very contemporary illustration of the invisiblehand at work.

Similarly, the overall economy in Hungary is becoming increas-ingly privatized throu^ the development of what used to be called "thesecond economy". For many reasons, the official statistics probablyunder represent the scale ofthe privatization of labor, with many state-owned companies virtually becoming empty shells. While the govem-ment may decry this loss of "its" assets, it may have been unrealistic toexpect political agencies with a handful of employees to be able toprivatize an entire economy. Probably, it is no more feasible to plan aneconomic transformation centrally than it was to plan a nationaleconomy centrally.

4 Conclusions

When examining Hungarian privatization from the perspective ofthe managers and employees working in privatizing companies wediscovered several aspects of privatization that have not been em-phasized in the literature in institutional and policy analysis. First, inour sample there was relatively little substantive distinction between"formal" or centrally-directed privatization and "spontaneous" or

316 I. BRANYICZKI. G. BAKACSI & J.L. PEARCE

company-initiated privatizations. Unfortunately, to date, the primarydifference has been that the company-initiated privatizations haveactually taken place and the companies are developing market-focusedprocedures and policies, while the centrally-directed privatizationsremain mired in delays. Second, the economic collapse ofthe region andvisible success of privatized companies have led significant numbers ofHungarian managers and employees to begin to welcome foreignownership and direction. Finally, the publicized centrally-directedprivatization programs represent only a fraction ofthe actual priva-tization occurring in Hungary.

REFERENCES

KORNAI J., 1990, The Road to a Free Economy: Shifting from aSocialist System, The Example of Hungary, New York, W. W. Norton.

KORNAI J., (forthcoming), "The Affmity Between Ownership Formsand Coordination Mechanisms: The Common Experience of Reformin Socialist Countries", in Journal of Comparative Economics.

M A R K 6 C Z Y L., 1990, "State Directed Profit Motive and ResourceDependency", Budapest University of Economics Working PaperWP1990/4.

MINTZBERG H., 1979, The Structuring of Organizations, EnglewoodCliffs, NJ: Prentice-Hall.

PEARCE J. L., BRANYICZKI I. and BAKACSI G., 1991, "AlawfulReward Systems: A Theory of Organizational Reward Practices inReform-Communist Organizations", Graduate School of Manage-ment, University of California, Irvine Working Paper OB91003.

STARK D., 1990, "Privatization in Hungary: From Plan to Market orFrom Plan to Clan?", in East European Politics and Societies, 4 (3),351392.

TARDOS M., 1989, "Economic Organizations and Ownership", in ActoOeconomica, 40 (1-2), 17-37.

CHANCES AND DILEMMAS OFPRIVATIZATION IN HUNGARY*

by

EvaVOSZKA

Budapest, Hungary

There are some general dilemmas of transition from a planned toa market economy which are refiected in the privatization process aswell. The first is whether the transformation should be led by a stronggovernment, on the basis of a detailed program, or by individualinitiatives and self-goveming movements by the economic actorsthemselves. In other words: is it possible to set up a liberalized,decentralized market system by centralized decision-making mecha-nisms?

On the one hand, serious doubts can be raised about the intentionsofthe economic actors. It is probable that they would prefer preservingor creating their monopolistic and protected positions instead of facingmarket competition.

On the other hand, it is obvious that the creation of a free marketmeans that the government loses a significant part of its power over theeconomy. There is no evidence that the leading political forces reallywant that. Parties and politicians having recently come to power couldfind it difficult or even hai^nful for the nation not to infiuence theprivatization process directly.

Nevertheless, the method of strong central control has obviousdisadvantages. Centralization of economic decisions may reproducethe traditional bai^aining mechanisms characteristic of Uie centrallyplanned economy. These methods are familiar both to the state apparatus

* The paper was presented in April 1991; thus the events of 1991-1992 arenot included in the analysis.

318 E. VOSZKA

and the economic units. According to the experiences of several dec-ades, transformations conceived and led by central political organs didnot prove effective. This method may even undermine the legitimacy ofthe new govemment by justifying the argument about the old style ofthe new regime and the lack of fundamental changes.

A second dilemma is whether the changes should be made gradu-ally or quickly, by one big jump or not. A marked feature of Hungary,after two decades of economic reforms is that there are fewer illusionsabout the step by step solution than in any other Central Europeancountry.

There are two other arguments of a political character againstslow transformation. First, the freely elected government has to showthat it is different from the previous one; otherwise it could loselegitimacy. Secondly, it has become obvious that a slow transitionwould preserve the old power structure (among others the strongbargaining position of big enterprises) in the economy.

However, there are some serious factors also of a political naturepushing the govemment in the direction of step by step changes. Arapid transformation would cause a lot of problems, such as a declinein the standard of living, increasing unemployment and inflation anda reduction of budgetary redistribution. So the legitimacy ofthe newregime can indead be threatened by large social strata concemed bythese disadvantages.

A third dilemma is the reliance on internal versus external forces.The latter, even if it is possible, means the involvement of additionalforeign assistance, direct investments or credits. The advantages arethe increase of sources for modernization and/or easing of socialtensions. However, foreign aid does not seem to be available, and thepreference of foreign ventures may hurt the interests of domesticinvestors and form enclaves in an underdeveloped country. Finally,additional credits would merely increase the burden of debt services,already too high now.

The fourth dilemma concerns allowing or tolerating the increaseof social differences, the tendency of inequity in the society - orcontinuous efforts at easing these tensions. This confiict betweeneconomic effectiveness and social justice can be especially acute in aperiod of intensive change.

Finally, the fiflh dilemma is the shape of the system to beachieved. Should or must Hungary go back to the initial stages of amarket economy? Or is it possible/desirable to jump over several stages

CHANCES AND DILEMMAS OF PRIVATIZATION IN HUNGARY 319

to try and reach the modem institutional and social forms of thatsystem? There would be obvious advantages to the latter solution.However, the problem is not only the feasibility of this attempt, but thepossible deformations of tiie new institutions as well.

1 The transformation of the ownership structure

In spite ofthe long history of debates on proprietary structuresand given that almost a year has passed since free elections, there is nocomprehensive program, no social consensus on the ways of transform-ingttie ownership structure. Nevertheless, three types of changes havebegun and have speeded up over the last years.

The first is the rapid increase in the number of private firms. Thenumber of economic organizations in Hungary grew from 10,000 to30,000 between 1988 and 1990. Most new organizations belong to theprivate sector - but the mtyority is small, employing less than 20people. Thus the weight ofthe private sector in the economy has notincreased concurrently with the expansion in the number of privatefirms.

Itmustbe mentioned that the wideningoftheprivate sector beganwell before the political tumover. In the early eighties different formsof small ventures were permitted and even stimulated by economicpolicy. As a consequence of this (and the reform process as a whole),wide social groups became acquainted with the noims and behavioralpatterns of the market and private activity. This factor seems to beextremely important for future transformation. Nevertheless, theextension ofthe private sector has rarely been connected with priva-tization of state assets. The majority ofthe new units involved onlyprivate capital.

Continuity and loose connection to privatization are also char-acteristic ofthe second type of change, namely the transformation ofbigstate enterprises into companies. This process began in 1987, and wasoften initiated and carried out by the firms themselves. The legal basisofthe process was the setting up of enterprise councils in 1985 in threefourths of all state enterprises. These bodies, consisting of employeesand man£^ers were given the right, among others, to appoint a director,to decide on merger and splitting up the firm, to set up joint venturesand stock companies with state assets. This was the last step ofdecentralization of proprietary rights from the government to theenterprises.

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In many enterprises only a part ofthe assets was transformed intostock companies, while the former state enterprise continued opera-tions with the remaining assets. In several other dozen cases (big) stateenterprises founded companies with each of their factories, plants andeven administrative departments one-by-one. The former enterprisecenter only took over the function of asset (stock) management. Al-though they called themselves holding companies, they remained stateowned enterprises without any shareholders. These "holdings" usuallyheld the majority shares ofthe new companies that have been foundedon the basis ofthe factories ofthe former big enterprise. At the level ofthe companies new owners appeared on the scene as well, but apartfrom foreign investors they were also state owned organizations: banksand enterprises that were given the right to buy stocks in other firmsor to make a debt equity swap.

This process of transformation of state enterprises into (a groupof) companies in Hungary was called "spontaneous privatization".Nevertheless, it cannot be considered spontaneous, because it wasstimulated by the government's restrictive monetary and fiscal policy,and was started and carried out by govemment organs in many cases.Taking into account the state proprietorship of the shareholders, itcannot be regarded as privatization either.

The ownership rights were transferred to private hands only in aspecial and limited context. The management's rights of disposalincreased, and were extended to the selling of state property and tocirculating the shares. Managers, however, did not become legalowners of state assets, nor did they convert their position into that ofproprietors, of which they have been often accused. In any event, it wasthe management of big enterprises and the directors of their dependentplants, who had or at least hoped to derive benefits from this process,extending their scope of decision-making power and maintaining theirmanagerial roles. These objectives, however, have not been reached formany. Agrowingpart ofthe old management has been replaced by newowners, who then are usually ^ven a generous compensation.

This has happened mostly in cases where foreign capital wasinvolved in the new companies. It was the third line ofthe changes, th at- contrary to the first two - meant privatization in the strict sense ofthe word. There were more than two thousand joint stock companieswith foreign capital in 1990, representing more than half a billiondollars.

"Spontaneous privatization" was criticized sharply by the oppo-sition parties before the parliamentary elections. The main contra


arguments emphasized that this process does not necessarily createnew and real proprietors; so the rights ofthe management are extendedwithout strengthening ownership control. The state has not gainedincome from the transformation, even if a part ofthe assets was sold toforeigners. The lack of competition between potential new owners anda lack of public control also poses problems. Therefore the suspicion of"selling out" state assets at a low price and that of corruption cannot bedisregarded.

These arguments may be in fact well-founded in many respects.Nevertheless, there exists another point of view in the background ofthe aversion to spontaneous privatization, one not discussed openly.Namely, the power claim ofthe new government to concentrate therights of disposal into its own hands, in order to have the opportunityto divide the state assets amongnewproprietors and to redistribute theleading posts among its own executive personnel.

Considering all these factors, not surprisingly, the ne wgovemmentcentralized the decisions concerning privatization and transformationof enterprise. A central organ, the State Property Agency (SPA) was setup under govemmental supervision with the right to control andapprove all deals of selling the state assets. Obviously, the newgovernment was anxious to answer the question: who is the owner. Itdeclared itself as the only seller. It proved to be rather uncertain,however, in defining who the buyers should be and what methods ofprivatization should be applied. The govemment program published inOctober 1990 listed almost all possible directions of transformations.

Two types ofprivatization, initiated by the SPA started in 1990.One is the selling of retail trade shops and restaurants to domesticinvestors. (Foreigners are excluded from small privatization.) In thefirst six months after the passing ofthe law, small privatization wasextremely slow. The main reasons were the uncertainty of the realestate owners (the local government's proprietorship) and the lack ofpreferential credit for the buyers.

The second central initiative was the so called First PrivatizationProgram. The State Property Agency published a list of twenty bigenterprises to be sold. A tender was written out for consulting firms tooutline the program ofprivatization, including the method of findingnew owners. Almost every tender was won by foreign consulting firms,so, most probably privatization will be carried out by foreigners as well.

Beside these steps, there are two other types of privatizationmentioned in the government program. One is the employees' stock

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ownership program (ESOP). The legal framework and financial back-ground have not been published yet. Nevertheless, managers andworkers can buy shares in their company on preferred conditions. Theother type designates that the group of new owners be local govemmentsand special institutions like pension funds and insurance companies.At this point the problem of legal uncertainty emerges in the first caseand the lack of institutions in the second one.

2 Conclusions

Comparing the dilemmas with the brief summary of changes, wecan now draw some conclusions. The freely elected govemment hassolved only one of the dilemmas. It has declared its authority tocommand the process of changing the ownership structure. The deci-sion-making mechanism has thus been centralized, yet without clearlysetting the aims and preferences. We have seen that in the govemmentprogram all types of new owners are listed. The small privatizationprogram prefers domestic entrepreneurs. The First Privatization Pro-gram seems to prefer foreign investors. The dominance of the firstsolution would mean a traditional ownership structure, while thesecond (together with a significant role of institutional proprietorship)would mean a modernized structure.

The centralization of decision-making power was declared inorder to speed up changes. In the first year after setting up the SPA noacceleration was seen. The SPA is often accused of operating in abureaucratic way, thus slowing down the transformations. The newversion of the government program, published in February 1991,emphasizes the necessity of revising the role of the SPA and ofintroducing self-privatization of enterprises. Thus decentralized meth-ods may appear again.

To sum up, most basic dilemmas of privatization are still notsolved. The conceptions are rather confused lacking clear aims andpreferences; they shift from decentralization to centralization and thenback again. One reason for the confusion may be the conceptual andpolitical weakness ofthe govemment. On the other hand, civil societyhas not been organized yet. The building up of associations for theprotection of common interests, the process of reshaping trade unionsand forming other types of independent organizations all are very slow.Considering that these factors are both of a structural nature andcannot be changed by "good" ideas or central programs, we will have to


face a slow, uncertain process of transformation starting in severaldirections simultaneously.

The probable scenario of changes may very well be an eclecticassortmentoftransformations,includingfluctuationsbetween centrallycontrolled changes and spontaneous ones. There is no real guaranteefor a favorable outcome for either economic efficiency or for socialjustice.

THE BACK DOOR: SPONTANEOUS PRIVATIZATION IN HUNGARY

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