Monday, March 14, 2005

Privatization revisited

A lot has happened since I have been posting here regularly. One of the most interesting from my point of view is the court annulment of the Kryvorizhstal steel mill privatization, the mill sold to Kuchma’s son-in-law, Pinchuk and to Donetsk oligarch Akhmetov. The good thing about it is that it will reverse what all have considered to be a cooked deal to give Kuchma people a valuable state asset. The steel mill was sold to both of these men in the face of higher bidders like Russia’s OAO Severstal and US Steel.

The real problem though is that this might have opened up the reconsideration of most of the privatization deals made during the 1990s, if not all of them. That amounts to about 3000 businesses from what the news has reported. And Yulia Tymoshenko has confirmed that they will be looking into these deals.

This is a problem because it will turn off investors interested in looking at the Ukraine. What they will see is not the righting of severe wrongs but the re-nationalization of a company originally privatized. And if the government can do it once, it has the power to do it again as soon as the opposition gets its hand on the levers once more. The point is that title to these companies has to be quieted in some way in order for investors to have any confidence that they will not have a company nationalized out from under them. If there is any risk of that, any risk, they will avoid investing in the Ukraine. And there are indications that investors have had their confidence shaken recently with the announcements of these investigations.

That there were all sorts of state assets sold corruptly to friends and supporters of those in power there is no doubt. That may end up being true for all the privatizations that took place in the 1990s. A sense of justice would require that these be reconsidered so that the people can get fair value for these assets in the form of more money to the state coffers to pay for services and infrastructure. Ukraine needs money for both.

But an examination on such a wide scale will spook investors and they will end up going to more private property friendly countries to make what would be safer investments where they will not have this kind of threat hanging over their money. And there are any number of countries just a short distance to the west of here now members of the European Union where they would not be subject to that kind of risk.

Ukraine needs investment and it needs it badly. There are very few companies that have been able to modernize on their own here. The European Bank for Reconstruction and Development has been of some help in this providing loan guarantees for certain projects. But they have only worked in the hundreds of millions of dollars (or euros) and the Ukraine needs billions to modernize. That type of capital can really only come from private investments. The Ukrainian government needs to encourage that kind of investment, not discourage it. Taking action against all the privatized deals will not be encouraging it.

One thing that is driving this in part I think is not just getting justice for the people, though I do take them at their word on that. The problem is that the government faces a budget shortfall and 3000 deals made in the 90s could end up generating the kind of revenue to the state that would make their budget for next year. That is what Georgia did. They actually kind of blackmailed the people who got these kind of sweet deals under Shevardnadze (a real statesman, I think, who just got in over his head when president.) They went to these people and told them to cough up money on their assets. I don’t know if they paid the difference between the market price and the price they actually paid. But all of them came up with the money and the government was able to bridge somewhat their budget gap. I think this is some of what is animating the administration here.

But they stand to lose more than they might gain in the long run if they investigate so widely. The Ukraine represents more of an investment opportunity than Georgia does. One minister in the Georgian cabinet said, for example, that it would take 75 years for them to have a European standard of living. The Ukraine is only at the very most a decade from that if they get the policies right and investment starts coming in. (There are numerous opportunities for investors in the Ukraine which I hope to get to in the next few weeks here.)

The problem is that the government can’t just ignore the privatizations either. A lot of these assets were bought at fire sales (where there was no fire) by those who had the right contacts in government. That can rankle and end up souring people on market solutions if things get a bit tight or worse. So what should they do? They should go after the most egregious cases of banditry in the privatizations deals. To do this, they should sit down and set out, possibly by presidential decree, just what is an egregious case and then stick to that definition all up and down the administration. That may be a difficult thing to do but it must be done if they are going to have rule of law and are going to give people confidence in the Ukrainian governmental systems at all. These are problems here too that need to be solved. Giving more confidence to investors would be a result of this.

What about the rest of the companies? There could be some sort of non-privatization way of dealing with them. What about losing priority in dealing with the government if they don’t establish the transparency of their original purchase? Or maybe they could lose a tax benefit or some other benefit that might be useful in doing business if they don’t? At the very least, maybe the government could establish a list of companies that have cleared themselves of the cloud of having gotten their assets corruptly. That would at least give people some information about who they might not want to deal with.

In other words, what should be done with the rest of these companies is to put the burden on them to come clean or suffer some sort of penalty short of re-privatization. If they can’t establish this, then they should be required to pay to reinstate themselves in some way. This would serve to respect the property right while adding to the state coffers on all or most of these companies. And it would also give the people more confidence that justice was done.

This has to be done across the board too with the moguls of the administration who also acquired assets in the 90s. They should come clean on how they got hold of their companies too or it will look like business as usual, that is, the party who gets power puts it to the party who lost power. The courts will be working full time bringing people to some sort of justice, but it will be believed, if it is not the fact, that it is only the people who had certain party affiliations. That is the sort of thing Yuschenko has said he wants to change and I believe he does want to change it.

There is some indication though that the government may not revisit all the privatizations. Yuschenko himself has said that maybe a dozen or so will be but that is all. That would be good but what criteria they are using to go after what companies should be set out clearly. We’ll see if it happens.

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