The State & SOEs in Hungarian Privatization (PCEE 21, 1992) Gyorgy Holló

8/4/2019 The State & SOEs in Hungarian Privatization (PCEE 21, 1992) Gyorgy Holló.

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The State and SOEs in Hungarian Privatization

by Gyorgy HolloAdvisor to Hungarian State Property Agency

Program on Central and Eastern Europe Working Paper Series #21

This paper was presented at the Center for European Studies, Harvard University, on March 24,1992

The Hungarian privatization process can be characterized as a conflict between State-ownedEnterprises and the State itself as represented by the State Property Agency. To the extent

that prior to privatization, SOEs had to be renationalized, the process itself remains full ofinternal contradictions. The outcome of that conflict is uncertain, and it is not yet clear how farthe extensive powers of enterprise managers appointed by the previous regime will becurtailed.



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Poreword

To describe the t ransfo rmat ion of the Hungar ian economy from the

Stal in ist to market model is no t the purpose of this d iscuss ion

today . For one th ing , the f inal ou tcome is some time away and iti s no t a t a l l cer ta in whether Hungary wil l fo l low the North

American or the European sty le of cap i ta l i sm, or come up with yet

ano ther model . x t i s a lso too ear ly to judge whether the

Hungar ians -- or indeed any of the former socia l i s t b loc

members are go ing abou t economic t ransfo rmat ion the righ t way .

Rather , i t i s my basic premise that the most impor tant and

effect ive s t ructu ral refo rm for Eastern Europe is ownersh ip

reform. Which is to say that the st ructu ra l and transi t ional

p rob lems which these coun tr ies are exper iencing are roo ted in the

fa lse property r igh t d ist r ibu tion and the predominance of the

s ta te-owned and admin is tered economic sector .

The fact is that al l o f these countr ies are embarked -- o r are

abou t to embark -- on a h isto r ic journey , one for which there are

few bluepr ints and a varie ty of conf l ic t ing gu idelines . However ,

a l l agree that p r ivat iza t ion is an essen t ia l e lement in

d ismant l ing the command economic system and for get t ing the

market p lace in to operat ion. Again , there are var ious ways that

East European coun tr ies are seeking to ach ieve th is p rocess . For

we have to emphasize that p r ivat iza t ion is no t an end in i tse lf ,

bu t an essent ia l p rocess in economic t ransfo rmation . The



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methodo logy to ach ieve th is economic red is tr ibu t ion wil l

in f luence the economic and social l i fe o f these coun tries fo r

some t ime to come.

Which is why today 's top ic , The sta te and Enterp r ises in

Hungar ian Pr ivat iza tion , is o f major impor tance. However , I

would l ike to qual i fy my remarks to some ex ten t . The fact is

that Hungarian pr ivat iza t ion is in i t s beg inn ing and i t is

ext remely d if ficu l t to draw defin i t ive conclus ions abou t i t s

st rengths and weaknesses . That task wil l be lef t up to the

h isto r ians and students o f th is par t o f the world . I t i s far too

ear ly to make judgements .

Nor is i t my aim today to tou t the successes thus far of

Hungar ian economic t ransit ion and transfo rmat ion . Ind icat ions

are favourable and the process in Hungary leads al l the o ther

t ransfo rming coun tr ies in the area . According to the s ta te

Property Agency 's annual ta l ly , by the end of 1991 , more than 10

per cen t o f the Hungar ian economy passed from sta te to pr ivate

hands. In addi t ion , a major i ty of fo re ign investment go ing to

East Europe -- so crucia l to the t ransfo rmat ion process - - found

i ts way in to the coun try . Al l in al l , to date rough ly a quar ter

o f Hungary ' s 2000 sta te-owned en terp r ises have at leas t s tar ted

on the process of pr ivat iza tion . These are facts which speak

wel l fo r the coun try , i t s peop le and its leadership .



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However , what I would l ike to exp lore today is the very natu re of

the pr ivat izat ion process . speci f ica l ly , how does the Hungar ian

process d i ffer f rom those in the area and perhaps more

speci f ica l ly , what are the dynamics between the state and the

s ta te-owned en terp r ises of today . Being a member of the s tate

Proper ty Agency , I would have to confess a certa in amount of

b ias, though as my conclus ions wi l l ind icate , I have many

quest ions about the ro le that we p lay in the process . However ,

s tuden ts o f East Europe shou ld no t feel uncomfor tab le wi th the

ambigui t ies since in this par t of the world appearances are of ten

deceiv ing and many things are no t the way they appear to be.

But to arr ive at my goal , I would like to take a sl igh t t r ip back

in to the recen t pas t which may be famil iar bu t which is

necessary.

Role and Expecta tions of Kanagement

The rela t ionsh ip between the sta te and sta te-owned en terpr ises

(SOEs) in the command-economic systems of Eastern Europe has been

a complicated one. perhaps none more so than in Hungary .

The wholesale nat ional iza tion of pr ivate proper ty dur ing the

1940s and 1950s lef t a lmost the en t i re economy in the hands of

the s tate . In most cases , appropr ia t ion of pr ivate proper ty

included even very smal l re ta i l out le ts . Wholesale



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co llectiv ization of agr icul ture proceeded in fi t s and starts and

was completed after the 1956 upris ing. In fact , Hungary fol lowed

the Stalin ist blueprint of the Party control of the means of

product ion -- as well as dist r ibution.

As has been wri t ten by many observers of the socia lis t b loc, by

the 1960s the command model was losing steam. To a greater and

lesser degree , several members of the b loc began to experiment

wi th reforming the system. We al l know about the Hungarian HEM,

int roduced in 1968 and cont inued more or less unti l the poli t ical

changes in 1989-90. In fact , Hungary was the only one in the

bloc who never completely ret reated from its reforms but

continued to t ry to implement them as much as i t was possible

g iven the pressures from Moscow and fellow bloc members .

The crucia l aspect of the HEM for us here today that Hungary has

attempted to reduce i ts cen tra liza tion of the economic

decisionmaking by pu tt ing more decision-making on the production

levels. cri t ics of the Hungarian reform process point out that

this meant that instead of fo rmal control mechan isms the system

became a kind of IIbargainingll style between enterprise managers

and the minis tr ies. For our purposes, th is has had the resu lts

o f making the relationsh ip with the centre more uncerta in , but a t

the same time, more flexible as wel l . In other words, p lan t

managers had to become more f lex ible and creat ive in order to

keep receiving their accustomed bonuses . Which , of course, did



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not necessar i ly mean that this f lexib i l i ty was towards the

consumer . Qui te the con trary . In effect , p lan t managers became

closely in ter twined with the po l i t ica l apparatus . Thus , the

circ le closed and in Hungary , as a resu l t of the var ious at tempts

at decen tra l izat ion , these managers secured a preeminen t posi t ion

for themselves . But as Kornai , among many others , observed :

. . . . .le t us no t harbour i l lus ions: the manager of a sta te-

owned f irm is no t an en trepreneur. There is no get t ing away

from the fact that he, l ike the heads of o ther s ta te

ins t i tu t ions, i s ou t to expand h is spend ing l imi ts as far as

poss ib le . The manager of a s ta te-owned f i rm also wants to

invest more , obta in an ever greater amount of hard currency ,

impor t more machinery and equ ipment f rom hard currency

markets , t ravel more and le t h is co l leagues do the same; and

of course he wants to pay h igher wages s ince th is wi l l boost

his popu lari ty among the employees and thereby ease the

tensions around him." (Jinos Kornai , Socia l is t

Transfo rmation and Privat iza t ion: Shif t ing from a socia li s t

System. p .281)

Having said that , the 1968 refo rms have made i t poss ib le for a

cer ta in amount of en t repreneursh ip -- or more speci f ica lly ,

" in t rapreneursh ip" -- to ex ist in Hungary. The bureaucrat ic

obstacles remained , bu t wi th in indust r ies developed the so cal led

"au tonomous groups within the f i rm" known as VGKK. These groups

cou ld con tract ou t f rom thei r workp lace piecework product ion for



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which they would be ab le to earn many t imes thei r normal

salar ies . For the en terp r ise th is had the effect o f more

eff ic ien t use of ex ist ing capacity . For the workers , in add i t ion

to an increase in earn ing capacity , i t served to keep the

creative en trepreneur ia l sp i ri t a l ive .

I t i s suggested here today that in Hungary , in fact , the economic

p layers gradual ly gained a certa in amount of independence from

the communis t party whi le becoming a par t o f the po l i t ica l

apparatus. Many Hungar ians today consider that economic managers

became the backbone by which the s tate apparatus con t inued to

main tain i ts power as they str ived for more and more say in the

co un tr y' s d ir ect io n.

A major step in th is d i rection was the int roduct ion of the Law on

Enterp rise Counci ls in 1984 . While it was designed to fu rther

decen tra l ize economic decis ionmaking, and ensure production

sensi t iv i ty to the consumers , i t had the effect o f making

production un i ts a lmost independen t f rom the min is t r ies and ,

hence, f rom the par ty . wi th in the factor ies as in the

Yugoslav experience i t was no t too d if f icul t fo r management to

assume contro l over the en terpr ise counci ls s ince, accord ing to

the law, hal f thei r membersh ip was appo inted by management.

wi th in a few years , 70 per cen t o f s ta te-owned Enterp r ises (SOEs)

were managed by these counci ls , thus by the managers . To

underscore the po in t , Janos Martony i , p rivat iza t ion commiss ioner



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in 1989 sta ted :

l iThe most impor tan t Hungarian pecu liar i ty • •• is that in

Hungary , in 1984 a very pecu l iar si tuat ion was brough t abou t

and th is may be cal led semi-pr ivat iza t ion , the essence of

which is that where the major i ty of en terp rises are

concerned , the s ta te - - whi le main ta ining an abst ract r igh t

o f ownersh ip -- en t rus ted the huge majori ty , v i r tual ly all ,

en ti t lements derived from this ownersh ip to the en terp r ises.

The resu l t has been that s ince then these en terpr ises have

owned themselves . The sta te bel ieved that th is ownership

r igh t would be pract iced by sel f-govern ing en terp r ise

councils . Th is was no t what happened : the pract ice of

ownersh ip s l ipped from the very f i rst moment in to the

en terp r ises . . . . . ( Janos Martonyi , Hungar ian Quarter ly , spr ing

1990)

The nex t step was enacted on January 1, 1989 . The Law on

Business Associa t ions included provis ions fo r conver t ing SOEs

in to jo in t s tock and l imi ted l iab i l i ty companies. The lawmakers

d id no t ant ic ipate the convers ion of sta te assets in to pr ivate

ones , bu t the law al lowed en terp rises to found such corporations

which provided the legal loopho le fo r what has become known as

"spon taneous privat iza t ion" in Hungary.

The essent ia l s teps fo r conver t ing po l i t ica l in to economic power





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that Hungar ian en terp rise needed . Rather , accord ing to cr i t ics ,

i t at t rac ted the "fas t buck" ar t i s t s who were in it for the qu ick

tu rnaround .

One aspect o f the 1984 and the 1989 laws was to make enterp rise

managers de facto owners of s tate assets. En terpr ise counci ls

repor ted to no Board of Directo rs o r s tockho lders . They had to

bargain with the s ta te fo r investment cap ita l , bu t their success

did not depend on the v iabi l i ty or the prof i tab i l i ty of the

en terp r ise , ra ther, on the po l i t ica l connect ions of thei r

managers . S ince the s ta te also undertook to underwri te

en terp r ise losses, there was l i tera l ly no con tro l on investment ,

spend ing or product ion by SOEs. Management was ab le to pay

i tse lf huge bonuses wi thout any regard to the v iabi l i ty of the

en terp r ise , which cou ld be then used to buy the en terp r ise using

the spon taneous pr ivat izat ion loopho les . As one observer pu t i t

in 1990 :

"We faced an atomized economy, in whoever jus t happened to

ho ld the marshal 's baton , no t received on the grounds of

ab i l i ty bu t handed down from above, was the master o f the

enterp rise , p r ivatized the g iven assets . (Is tvan csi l lag ,

Hungar ian Quar ter ly , sp r ing 1990)

One of the outcomes of spon taneous privat iza t ion, fu r thermore ,

was that en terpr ise managers could now become de ju re owners of



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s tate property as well . To sum up, spontaneous pr ivat iza tion is

thus a process whereby po li t ical cap ital is converted in to

economic power and ownersh ip .

We should not forget that this process whereby en terp rise

managers consol idated their power over a large sector o f

Hungary ' s economy did not occur in a po li t ical vacuum.

Decentral izat ion of economic decisionmaking and economic reforms

are basically incompat ible wi th the centralized nature of

po li t ics. I t has been argued by observers of the sov iet Bloc

that , in reali ty , fundamental economic refo rms would result in

the loss of Party power . Consequently , as we have seen in the

more recent soviet example -- pr ior to its collapse -- only

gent le t inkering with economic refo rms would be possib le.

otherwise, as we may judge by the even ts o f Tiananmen square , the

Party may have to take drastic measures in order to at tempt to

reestabl ish its authority .

In Hungary, as one observer no ted:

(in the autumn of 1989) The state-sociali st economy,

cri t ic ized for decades as too tight ly con trol led by the

state, now found itself in a si tuation where the already

fuzzy l ines of con tro l were spinning from ambigu ity to near

dissolution. In such circumstances, enterprise directo rs,

as the most powerful agents in that economy, could act wi th

unparalleled independence. Their most decisive actions were



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in the new area of pr ivat izat ion . (David stark , Pr ivat iza t ion

in Hunqary : From Plan to Market o r f rom Plan to Clan? p .364)

Fur thermore , the laws passed in 1989 d id no t fo resee the

pol i t ica l chanqes to come, nor the consequen t economic

t ransfo rmat ion that would be necessary .

In Hunqary, by the ear ly 1980s the economy was in ser ious

d if f icu lty and the Kadar req ime was los inq con trol . Ex tensive

borrowinq from the West served to keep the popu la t ion ' s s tandard

of l iv inq from deter iora t inq, bu t d id l i t t le fo r solv inq the

prob lems of decl ininq production . By 1982 , the qovernment came

with in an inch of havinq to reschedu le it s fore iqn debt . We may

recall the impl ic i t deal o f the Kadar qovernment after 1956 which

asked that the peop le no t quest ion i ts leq i t imacy and in re turn

i t would del iver a better l iv inq standard . In the 1980s the

par ty was unab le to del iver withou t huqe western loans . As a

resu l t , un l ike in the res t o f the socia l i st b loc , po li t ical

transformat ion in Hunqary was no t qained by publ ic pressure or

fo rce , bu t was essen t ial ly neqo t ia ted . However,

" the specif ica lly pol i t ica l vacuum of mid 1989 was no t a

leqal vacuum, and • •• the neqo t iated t ransi t ion of po l i t ica l

power was no t a neqo t ia ted t ransi t ion of economic power ."

(David stark , p .262)



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Which is to say that the more difficult part of the change

process, economic t ransit ion, was st i l l outstanding. Clearly ,

the appropr iat ion of s tate assets via spontaneous pr ivatiza tion

was unacceptab le to the transit ional Nemeth government. In

addit ion, the extremely high per-capita fo reign debt made it

imperative to sell state assets ra ther than redistr ibute them.

The newly elected government of Hungary thought of pr ivat iza tion

as a way of balancing Hungary 's budget as wel l as to use it to

repay foreign deb ts.

However, with the s tate assets s l ipp ing away through spontaneous

privat izat ion , soon there might not be any assets to put on the

market. Through this pecul iar process - - which in Poland was

appropriate ly called "nomenclatu ra privat izat ion" -- managers and

thei r po li t ical al l ies would be able to secure themselves

preeminent posit ions in the new system.



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The Ro1e and EXpecta t ions of the Workers

However , befo re we get in to the Hungar ian so lu tion to

privat iza t ion, we shou ld take a look at the ro le of the workers

in th is equat ion . We must remember that the communis t Par ty

ru led in the name of the work ing class and -- whi le the ideo logy

has los t i t s leg it imacy -- i t created an expecta t ion of

part ic ipat ion and equali ty among workers . As a resu l t , employees

have become compet i tors wi th the s ta te for c laims on sta te assets

s ince, in effect , p r ivat iza t ion was in conf l ict with enterp r ise

counci ls .

Whi le it was general ly t rue that these councils were dominated by

en terp rise managers , workers s t i l l fe l t that they too shared

ownersh ip in thei r p lace of employment - - a t least as far as any

div is ion of assets were concerned . Consequent ly , any realignment

of the propr ie ty of s ta te assets would have an immediate impact

on worker expecta t ions . In o ther words , they expected a share in

the pr ivat iza t ion process . To some ex ten t , that i s a pr imary

reason why in Poland , fo r example , the government has decided on

a d is tr ibu tive pr ivat iza t ion scheme for a large par t o f the

economy. While in Hungary th is was no t to be, s t i l l , worker

expecta tions would have to be deal t with .

In addi t ion, fo r over 40 years , workers looked at employment as



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an inherent right. Hungarians especia lly have some long histo ric

react ion to unemployment as being equ ivalent to ext reme pover ty

and beggarness . consequent ly , since any economic rationalizat ion

would certa inly mean the reduction in the work force , workers

have a vita l in teres t in -- and fear of -- the pr ivat iza tion

process.

An especial ly interest ing and exp losive issue is the

privatizat ion of union proper ty . During the communis t era,

unions served as a transmission belt f rom below to the party , as

well as provid ing social ameni t ies to its members. To be sure ,

these amenities were of ten used as the means of social and

poli t ica l control , bu t that is ano ther issue. In any case,

unions, organized along company l ines , became operators of

extensive holiday resorts in some of the most des irable parts of

Hungary.

The diff icu lty is that often these proper ties were carried on the

company 's books -- as much as these books could be rel ied on.

consequently , when companies are so ld to investors , un ions often

protest that their members ' p roperty is being along with the

company. I t is no t cer tain in most cases whose proper ty is being

actually sold and the fact that the o ld unions were largely

replaced by new ones fur ther complicates identi f ica tion.

In order to deal with the ex istence of the Enterprise councils,



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the government decided that those corporations which were

previously under worker management, could partic ipate in a

modified type of Employee stock OWnership Plan (ESOP). According

to th is p rogram, 20 per cent of the income from privatiza tion

would have to be ro lled back into the company. This served two

purposes: one, to s trengthen the company 's cash flow, and two,

part of the money would be used for allowing employees to

purchase up to 10 per cent share at a reduced cost .

Thus the paradox and contradiction: pol i t ics of envy which

desires state regulations, vs being fed up with the excesses of

sta te interven tion and the tota li tarian power of the bureaucracy.

Specifically , on the one hand Hungarian workers continue to

expect the state to protect them from the ravages of unemployment

and to level out somehow the inequal i t ies in economic power that

are beginn ing to emerge. On the other hand, they have become

exasperated up with state and bureaucratic in tervent ion dur ing

the las t 40 years, and want them out of their l ives. This

con tradict ion has al lowed poli t ical op inions rang ing from class ic

l iberal ism to strict stat ism to exis t and draw a modicum of

support from the vo ters. This range of sen timents often becomes

preoccupied with pr ivatiza tion po licy and practice which makes

the work of the pr ivatiza tion "watchdog" rather fascinating.



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The state Property Agency

Given that there was a policy decision to be made abou t who

really was the owner of the economy, there were two possible

cho ices : firs t , p rivatization from above, which implied that the

sta te would renational ize the assets before sale or distr ibut ion;

or pr ivat iza tion from below ("spontaneous pr ivatiza tion")

implying that the enterpr ise ' s workers and management were the

effective owners. In Hungary it was decided that ,

"An economy star t ing out from a cen tra lized system should

make a great effor t to preven t ownership r igh ts from being

assumed by fi rms' managers and workers in an early phase of

reform, by defin ing ownership rights clearly and assign ing

them as rapidly as possible to agents or inst i tu tions

ou tside the enterp rises." (Stanley Fischer and Alan Gelb,

Issues in Sociali st Economy Reform p. 11-12)

consequent ly , as a way of estab lishing a clear l ine of ownersh ip

of s tate assets , the government created the Hungarian State

Proper ty Agency .

Insti tu ted Karch 1, 1990, (as a part o f the Transformat ion Law of

June 1989) the SPA is designed to exercise ownership r igh ts over

state assets in the course of reducing the sta te ownership of the



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economy. speci f ica l ly , the s ta te Proper ty Agency was charged

with the management and u t i l iza t ion of s ta te assets wi th the aim

of faci l i ta t ing and regula t ing the pr ivat iza tion of s tate f i rms.

Unl ike o ther fo rmer socia li s t countr ies, Hungary p laced its main

emphasis on sel l ing sta te-owned en terp r ises to s t ra teg ic

investo rs .

The sta te Proper ty Agency is an organ ization that performs publ ic

service and is a legal en ti ty . The Agency is managed by the

government and is charged with the responsib i l i ty fo r exercis ing

the s ta te ' s ownersh ip r ights per ta in ing to sta te-owned assets

managed by the Agency . The Agency g ives accoun t of i t s

act iv i t ies to the Nat ional Assembly or i t s committees that deal

wi th issues re la ted to the SPA's act ivi t ies . The act iv it ies o f

the s tate proper ty Agency are superv ised by the Nat ional

Audi ting Off ice and are managed by an 11-member Board of

Directors , the chai rman and members of which are appoin ted by the

Pr ime Min ister . The Manag ing Directo r o f the Sta te Proper ty

Agency , who is in charge of i t s day- to -day affa i rs , i s appo in ted

and can be recal led by the government .

In November 1991 , the Pr ime Min is ter appo in ted a fu l l- t ime

min is ter o f s tate responsib le for p rivat iza t ion and promised to

br ing to Par l iament i t s long-awai ted privat iza t ion po l icy. The

leg isla t ion , a t th is wri t ing , has s ti l l no t appeared .



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In the s tate versus the SOEs confl ict , therefore, the s tate

Property Agency was appointed to represent the former . var ious

vested interes ts, left over from the former regime -- such as the

en terp rise managers - - saw their powers seriously th reatened.

However, they were faced with the reali t ies of a loss of markets ,

removal o f state subsid ies and the leg isla t ive power of the SPA.

It was recogn ized early that East European SOEs needed four

things desperately: new and up-to-date management, in jection of

capital , new technoloqy and new markets. The las t one was

especial ly crucial since the COMECON market collapsed and the

country 's larges t t rader, the Sovie t Union, became increas ing ly

less able to pay. And, of course , Hungary needed the income from

privatization to reduce i ts debts, repair i ts infrastructure,

recap ital ize its social welfare system and so on.

In order to facil i tate pr ivat iza tion the SPA developed specific

p rograms. Among these are investor-ini t ia ted pr ivatiza tion and

the simplif ied self -pr ivat iza tion programs. The former is

des igned to help investors f ind and purchase state assets. The

la tter serves to "privatize pr ivat iza tion" by taking the

bureaucrat ic mach inery out of the process and help s tate-owned

enterprises privatize themselves. At the same t ime, the SPA

fu lfi l s i t s role as a protecto r of s tate assets by ensuring a

fair retu rn for the properties so ld to private investo rs.



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A second importan t task of the SPA, the management of s ta te

assets , has been a d if f icu l t p rob lem from the beg inn ing. The

Agency is the holder of a varie ty of share por t fo lios of

pr ivat ized SOEs as wel l as of enterp rises whose major i ty or

minor i ty shareho ld ing was so ld to investo rs . To date it has no t

been decided what exactly the SPA was to do with these sta te

assets . P lacement on the s tock market is p roblemat ic due to i ts

poor perfo rmance and to the h igh in fla t ion rate in Hungary . Most

o f these shares are years away from declar ing d ividends -- i f

ever . There is a lso l i t t le exper ience in the coun try wi th th is

type of asset management , nor are there f inancia l veh ic les to

deal wi th them. A par t ia l so lu tion may be the Hungar ian

compensat ion Law which reimburses peop le ' s los t proper ty wi th

privat iza t ion vouchers. These wil l be issued star t ing Apri l 1992

and i t i s hoped that voucher recip ien ts wi l l t rade them in for

company shares . However , th is is far from cer ta in . Therefo re,

i t is l ikely that the s ta te wil l remain a substan t ia l shareho lder

in the pr ivatized secto r fo r some time to come.

In the new leg isla t ion , the government is expected to create a

l i s t of SOEs which wil l no t be for sale , o r fo r which it wil l

only al low minor ity par t icipat ion . The management of long- term

government assets wi l l be handed over to a ho ld ing company for

which the privat iza t ion new minis ter wil l a lso be responsible .

perhaps some clear d irect ion as to where the government wishes

privat iza t ion to lead wil l be def ined as wel l .



21

At its beginn ings, the founders of the sta te Property Agency

envis ioned a to tally di fferent organization than i t has tu rned

out to be. Spontaneous -- or company- init iated pr ivatiza tion --

would remain the pr imary method by which state assets would be

p laced in the private secto r. Xn addi t ion , the SPA would be a

compact organ izat ion that would also iden tify "packages" of h igh-

profi le and rela tively successfu l en terp rises, incorporate them

and place their shares on the fledgling Budapest stock market .

Hence, in Sep tember 1990, 20 leading enterpr ises were announced

as the First Privat izat ion Program. Soon af terwards, a group of

so-cal led "emptied" SOEs were to be included in the Second

Privat iza tion Program. Considera tion was given for subsequent

p rograms aimed at sell ing corporations in the build ing and wine

trades.

Several th ings went wrong. Fi rst , the SPA was not prepared

organizational ly nor financial ly -- for these programs.

Hungar ians -- as other East European governments -- came to

real ize that sel l ing sta te-owned enterpr ises was not going to be

quick nor cheap. Donor funding would have to be mobi lized to

facil i tate the incorporation of these SOEs (which included

valuation, sett ing books in order, audi t ing , etc) to pay for

expert ise which could on ly be found in the West. In addit ion,

the stock market , which had about 10 lis t ings at the time, cou ld

no t absorb a large in flow of shares. While the SPA was dealing

with these problems, the selected corporations ' f inancial



nsituation was deterioratinq and the Aqency found itself in a

position of tryinq to sell assets whose value was chanqinq

constantly. The result is that after nearly two years, none of

the First Privatization proqram enterprises was sold. The

proqram privatization methods was abandoned entirely in late

1991.

It became obvious that enterprises would have to be incorporated

and sold one at a time and the process would be long, costly and

complicated. The SPA orqanized itself alonq industrial lines

with case officers dealinq with a number of firms. At this point

in time, the average case load is 3S SOEs. Not surprisinqly, the

Agency is sufferinq from hiqh staff turnover resultinq from

burnout. It is expected that by the end of 1992 -- due to World

Bank fundinq the staff of the SPA will reach 301, or double

from its present number. This complement bears a comparison with

the Treuhand which has a considerable amount of financial

resources and a staff of around 3000.

The achievements and speed of Bunqarian privatization are unique.

Durinq 1991 the SPA approved the transformation (or

incorporation) of 189 companies with a book value of BUF 316

billion, ($4.2 billion) revalued at BUF 418 billion ($5.6

billion). [(By comparison, in 1990,27 enterprises were

transformed with a book value of BUF 26 billion ($340 million),

revalued at BUF 41 billion. ($S40 million)] The intensity of the



23

process is indicated by the fact that t ransformation and

privat izat ion have begun by one-half of the 2000 enterpr ises at

the beginning of 1991 . The 1991 income of the SPA (real ized

either in for ints or in fo reign currencies) exceeded HUF 40

bi ll ion ($533 mill ion).

One problemat ic aspect of 1991 's pr ivat iza tion income is that 85

per cent was in terms of foreign currency . Which means that

Hungarian entrepreneurs are only a very minor part of the

p riv atiz ati on pr oces s.

The resul t is that , from 90-per cent sta te ownersh ip in 1989, at

the end of 1991, less than 80 per cen t o f the economy operates

under direct government con tro l . Twenty per cen t o f the

previously s tate-owned property , at a book value of HUF 370

bi l l ion ($4.9 b il l ion) , i s in corporate form with at leas t 50 per

cent of i t con trol led by the private sector. To date, over half

o f a ll foreign investment in the former socialis t b loc has come

to Hungary , out of which approximately 60 per cent have been to

transformed or pr ivatized enterpr ises . The res t has come in

"green field" investment or in join t ven tures with already

p ri va te c or po ra ti on s.

Enterp rise managers and liberal economists are cr i t ical o f

cent ral ized privatizat ion. They contend that the o ld min istr ies '

power was handed over to a new "Min istry of ownership" and that



~

the SPA is real ly a con tinuation of cen tra l ized ownersh ip and

contro l . The Agency, af ter a l l , i s an arm of the government and

i ts p rocess has remained a high ly cen tral ized one. The

government is no t the best agent fo r p r ivat izat ion , ra ther , the

process i t se l f shou ld be pr ivatized . Being a propr ie to r o f sta te

assets as well as i t s agen t for s tate dives ti tu re, these ro les

may represen t a confl ic t o f in teres t . And in the f inal analys is ,

the SPA may in t ime develop an in teres t o f i t s own and may turn

ou t to be a powerfu l bureaucrat ic agen t pursuing its own surv ival

in teres ts . o thers are concerned that the Agency may become an

arm of the po l i t ica l par ty in power . And so on .

Defenders , however , po int ou t that i t i s no t the Agency 's task to

accumulate , but rather to d ispose of s ta te assets . I f the SPA

was no t created to con tro l spon taneous pr ivat iza t ion , there migh t

have been l i t t le property lef t for the new state to t ransfo rm in

a rat ional manner . Fur thermore , the SPA makes every at tempt to

keep transparency in the fo refron t o f the pr ivatiza t ion process.Most sa les are tendered ou t pub l ic ly even in cases where an SOE

finds a fo re ign par tner wil l ing to enter in to a join t ven tu re .

While the ach ievements have been signi f ican t , the process has

been more complex than prev iously real ized . There is much to be

learned and app l ied to fu tu re programs and transact ions i f the

government ' s target o f hav ing 70 per cen t o f the economy in

pr ivate hands by 1995 is to be real ized . In the con tex t of our



2S

discuss ions today , however , we can d if feren t ia te between the

Hunqar ian treatment of en terp r ise managers f rom that o f o ther

fo rmer socia l i s t coun tries . In Hungary , the s ta te - - that i s the

SPA sought on ly to change ownersh ip of s ta te assets ; i t d id

no t seek to purge or remove the ex is t ing manaqers. In fact , the

mandate of the SPA does no t include the management of s ta te

assets . Nor can it remove managers wi thou t po li t ical

repercussions even though i t has the power to do so .

Some of the large investo rs in Hungary so far are : Sanof i , un i ted

Biscu i ts, General E lect r ic, Elect ro lux , Nestle ' s , S iemens and

Phi l ip Morris . In addi t ion , General Motors of the United States

and Suzuk i Motors of Japan have invested in green fie ld

en terp r ises in Hungary .

~he Lehel Example

In March 1991 , Elect ro lux bought 100 per cen t of the Hungar ian

Lehel fr ig idai re manufactu rer . The workers , un ions and the local

government were al l concerned that the new capi ta l is t owners

would pu t an end to the socia l ameni t ies they have enjoyed for

decades . In the even t , however, the p lant skat ing r ink, bowling

al leys , k indergar ten , creches and ho l iday resor ts are being

main ta ined by Elect rolux . The one except ion is the company zoo,

complete wi th lions , which the company offered to the local

government as a gi f t .



26

Lehel was founded in 1952 and developed i ts coo l ing equ ipment

product pro f i le in 1964 . Unl ike most Hungar ian manufactu rers , i t

has tu rned a profi t even in the 1980s; however , by 1989 i t found

that i t needed cap i tal in order to main ta in i t s market share and

therefo re began to look for fo reign par tners . Based on a long-

term rela tionsh ip with Elect ro lux the company sough t to sel l them

a 26 per cen t share . However , in August 1990 the SPA in tervened

and took Lehel under i t s management .

At that t ime, i t became obvious that E lect ro lux wished to

purchase 100 per cen t o f the company to which the SPA agreed ,

thus pav ing the way to the f i rs t ou tr igh t purchase in Hungar ian

pr ivat iza t ion .

The Swedish company examined i ts acqu isi t ion and chose to

concentra te on the manufactur ing of fr igidai res . Due to the

co l lapse of the COMECON market , Lehel was undergoing a decline in

sales even before the purchase and , as a resul t , about 800employees from a tota l workforce of 4800 have since lef t the

company . These redundan t workers received very generous

severance packages by Hungarian standards . Most o f those who

lef t vo luntar i ly were manual workers who , according to repor ts ,

fe l t that i t was a mat ter o f t ime before they would be laid off

in any case . By con tras t , accord ing to a company spokesman,

Elect ro lux had no inten t ion of reducing i ts workforce , bu t has

la id off abou t a th i rd of the lower- level admin is t ra t ion ins tead .



27

During 1991, workers have received a pay increase averaging 40

per cent, a hal f of which was due to the company 's in tervent ion .

One concern the new company has is the environmental damage

caused over the last four decades . Its cleanup will be at the

expense of the purchase price which was kept confident ial by the

SPA. (ex tract from Magyar Nemzet , February 19 , 1992)



Privat iza t ion : so .e conf l ic ts and chal lenges

speed & s impl ic i ty

In the heady days after the po li t ica l t ransfo rmat ion , East

European governments , Hungary included, considered pr ivatiza t ion

of s ta te assets to be a h igh and immediate pr io r i ty . However ,

thei r th ink ing d id no t take in to accoun t the complexi t ies and

costs o f the pr ivatiza t ion process . Indeed , the la tes t

p ronouncements coming from the Russian Republ ic abou t p r ivat izing

every th ing with in six months or so is remin iscen t of East

European expecta t ions circa 1989-1990. S ince then , i t has become

obvious that the cond it ion of the SOEs and the lack of exper ience

in privat izing them under these ci rcumstances makes th is a

leng thy process. In add i t ion , in order to prepare SOEs for

purchase has proven to be extremely cost ly as wel l .

To g ive some examples : many sta te corporat ions have l i t t le idea

of thei r cap i tal resources. Office bui ld ings , warehouses and

o ther faci l i t ies were rou tinely g iven ou t by the minis t r ies o r

exchanged with o thers . consequent ly , an inven to ry of assets is

o ften necessary before the SOE can be incorporated . And of

course , we need no t dwel l upon the prob lems of sov ie t Bloc

bookkeep ing . Suffice to say , these have to be updated to western

s tandards before the companies can be incorporated and so ld.



29

In Hungary, due to the inabil i ty of the SPA to br ing these

problems and complexit ies to the general consciousness, the

populat ion is impatient wi th the speed of privat izat ion . That

is, they want i t to go fas ter .

Protection of s tate assets

One of the founding pr inciples of the SPA is the protection of

state assets during the pr ivatiza tion process. We may recall

that the organizat ion was brought about largely to check and

regu late spon taneous pr ivat iza tions which resulted in state

property being transferred in to private hands or beyond state ' s

reach . However, there are some substant ial l imitat ions to a

c om pl et e p ro te ct io n.

Fi rst , according to the SPA's charter, transactions under HUF 30

mill ion (abou t half mil l ion dollars US) do no t have to be

reported by the state corporations. Thus, the company cou ld be

sold piecemeal wi thout reference to the SPA.

Secondly , there is the s ize of the SPA itsel f . At present i t

consists o f abou t 150 people and is expected to rise to a li t t le

over 300 by the end of 1992. Even if the Agency were so

inclined, th is is not a sufficient number for pol icing all the

corporations.



30

consequen t ly , we may observe an in teres t ing phenomenon which is -

- I 'm certa in repeated th roughout the fo rmer communist bloc .

Th is is a type of s low-mot ion wind ing up of SOEs by i ts

employees . A fai r ly typ ical example was a const ruct ion company I

adv ised dur ing the Fal l of 1991 in order to exp lain to the

general manager and his s taff the ru les of self -p r ivat izat ion .

I t became ev iden t that a lmost none of the some 1500 employees the

corporation carr ied on its books -- and con t inued to pay -- came

in to work excep t to p ick up their month ly pay . Management

con t inued to pay i tse l f the usual bonuses . The one h i tch was

that the corporat ion has no t had any work for over 18 months. To

pay thei r wages and bonuses , they ren ted ou t the downtown

Budapest o ff ice b loc which was ass igned to the company some t ime

ago , and star ted sell ing off or ren ting ou t company faci l i t ies to

the pr ivate secto r .

Accord ing to ind icat ions, there are many SOEs in the same

si tuat ion . They are clear ly fr i t ter ing away state assets to

con t inue to employ themselves . But would i t make much sense to

th row these companies in to bankrup tcy and cause massive ins tan t

unemployment? Or -- since most SOEs hold each o thers ' IOUs and

the banks were cap i ta l ized with such paper - - would no t the whole

house of cards co l lapse?

Po l i t ica l ly , th is process is ' also becoming very worry ing . peop le

who are no t themselves benefi t t ing from privat izat ion see the



31

fo rmer economic leaders con t inu ing to benef it long af ter the

system is supposed to have changed . Accord ing to many , the "o ld

comrades" have become the "nouveau r iche" and are scep t ical abou t

government wil l ingness to pro tect thei r in terests . I t is

d i f ficu l t to see what the sta te - - o r the SPA -- can do to remedy

th is si tuation . Clear ly , the type of wholesale changes in

leadersh ip by the communists in 1949 is unaccep table in a s ta te

of law. On the other hand , i f the s tate is not wi l l ing to carry

ou t a wholesale purge, then those with experience and connect ions

in the previous system are bound to remain on top in the new.

M an ag em ent r es ist an ce

The leg is lat ion creat ing the SPA has g iven i t ex tensive powers

bu t l i t t le d i rect ion . Once a state-owned en terp r ise is conver ted

or commercia l ized, the Agency becomes so le owner of i t s shares .

I t can then exercise propr ie tary contro l over the company "over

the shor t run" though -- as was ment ioned ear l ier - - i t was no tg iven the mandate to manage the en terp r ise . In cer ta in cases ,

such as i f the company management is h inder ing the pr ivat izat ion

process , the SPA may take the company under s ta te superv is ion and

name a board to manage i t .

As ment ioned ear l ier , managers see th is as a s tate in t rus ion ,

even renationaliza t ion -- which , in fact , i t rea l ly is. Though

some managers are ready and ab le to face the new chal lenges , by



32

and larqe they are unprepared and often unwil l inq to lose the

posi t ion of unfet tered power they have en joyed. Resistance to

the SPA is regu larly exper ienced by the caseworkers. Often

manaqers are ab le to en l ist the employees to thei r s ide by ci t ing

the ra te of unemployment resu l t ing from privat iza t ion .

Foreign investo rs are natu ra l a l l ies o f SOE management . They too

wish to pay as l i t t le as poss ible fo r sta te assets and are often

will inq to consider favourab le t reatment of ex is t ing management

in retu rn . The sta te Proper ty Agency , due to i ts mandate to get

a " fa i r" re tu rn on these assets , i s general ly seen to be a

h indrance to qu ick sales .

Bu t s ince the privat iza t ion process is d i f f icu l t to stop , another

tact ic is to undervalue the company assets in order to qu ickly

sel l to a fore ign par tner , a favouri te manoeuvre of the

spontaneous pr ivat izat ion era. By this managers hope that the

new owner wi l l be more l ikely to keep them in some responsibleposi t ion . s ince th is is con trary to the SPAs mandate which is to

get a fa i r re tu rn on sta te assets , case workers f ind themselves

in constan t conf l ic t over company valuat ions . Th is is somewhat

of an uneven bat t le s ince the SPA does no t have the manpower to

superv ise company valuat ions . In it ia t ing appraisa l by the SPA --

on the o ther hand means that i t is the Agency who would bear

the costs , someth inq which i t can rare ly afford .



33

One of the major financia l diff icu lt ies that the SPA has had from

its very beginning is that the Hungar ian government was unable to

suffic ien tly fund it to pay for the consultants necessary fo r the

transformation and privat izat ion of SOEs. Donor funding from the

World Bank, the PHARE program and USAID have helped. However , by

i ts very nature, donor funding is not quickly reactive. That is,

i t comes months after the need has been ident if ied and the

request winds i ts way around the fund ing agency 's bureaucracy.

Thus, th is is yet ano ther facto r slowing down Hungarian

privatization.

According to leg islat ion, by the end of 1992 all SOEs will have

to be t ransformed . Unless the law is changed , the SPA and SOEs

can look forward to a long and d iff icul t fal l and win ter.

SPA apparatus and lack of experience

As was mentioned earl ier , the Agency is under-resourced to carry

out the task it was en trus ted with . The doub ling of its staf f in

the coming months will a l lev iate the situat ion in the long run

bu t will b ring about fur ther organizational problems in the

coming year.

The fact is that i t is almost impossible to find experienced case

officers and managers for the organization. After a ll , the

privatization process is a new one and there are no precedents to





The orqanization has been under attack from the Minist ry of

Finance durinq much of 1991 who wanted the SPA to be incorporated

into the ministry and, therefore, more of the proceeds could be

used to payoff Bunqary 's external debts. On the other s ide, a

qroup of Members of Parliament wanted all cases of privatizations

reopened in order to see whether the s tate received its fair

returns. Neither of these efforts succeeded and with the naminq

of a Minis ter of s tate for Privatization perhaps many of the

polit ical batt les will abate .

s tr uc tu ra l e co no mi c p ro bl em s

I have already alluded to the problems with auditinq and

valuation of SOEs in Hunqary . These serve to s low down the

privat ization process as well as makinq i t more expensive than

was expected . As wel l , the result inq uncerta inties may be used

by enterprise manaqers to hinder economic transformations and to

lay the SPA open to charqes of undervalu inq SOEs.

Hunqary 's h iqh inflation rate is also a considerable problem. In

1991 it came in around 35 per cent and accordinq to qovernment

predict ion it may be lowered to around 25 per cent in 1992. Such

inflat ion rates influence all potential investors , especially

domestic ones. At the moment the banks will pay a net earninq of

around 27 per cent on deposits . This is much safer and bet ter

than many other investments . statist ics indicate that Hunqarians





of Bast European bureaucracies. Suff ice to say here today that

this body is not an inqredient of the solution but a substantial

port ion of the problem.



Conclusions

In this presenta t ion I have tr ied to out l ine and i l lust ra te some

of the contradic t ions and confl ic ts in the Hungar ian

priva tizat ion process. To l ist them al l would take much more

t ime than there is available here .

Perhaps the most important quest ion in this regard is whether the

sta te has intended -- through its pr ivat iz ing agent the SPA -- to

curb the transfer of managers' power from the old regime to the

new. The Agency has managed, to a great extent , to prevent the

abuses of the spontaneous pr ivat izat ion era . I t has not -- as I

t ried to point out - - succeeded, a t least in the shor t run, to

prevent enterpr ise managers from cont inuing to enjoy the

advantageous posi t ions they have atta ined during the communist

era . The fact tha t they have , may become a ser ious poli t ica l

problem for the government in the foreseeable future .

Essent ial ly , however, there are fundamenta l problems in the way

Hungar ian pr iva t iza t ion is proceeding which should be ment ioned.

Fi rst of these is that i t i s a government organiza t ion, the Sta te

Proper ty Agency, which is in charge of the process . Clear ly , a

governmental body is not the best one to carry i t out , but there

may be li t t le choice . I t i s an advantage in Hungary that the

SPA is not a government depar tment as i t i s in other East



European sta tes which would make it even more dependent on

e ve ry da y p ol it ic s.

Secondly, whi le I think the Hung~rian way of pr ivat izat ion

tha t i s by se ll ing state asse ts rather than redist r ibut ing them -

- is the r ight way, there is the danger tha t the process wi ll

take too lonq. Redist r ibut ive pr iva tiza t ion -- such as the

Pol ish or Czech effor ts -- has the benef i t of qett inq the

government out of the economy fast . I t remains to be seen

whether Hungary wil l develop a priva te sector soon enough which

wil l counterbalance the dangers of cont inuing publ ic ownership .

Thirdly, i t must be emphasized that in East Europe , pr iva t iza t ion

is a race against bankruptcy. As was ment ioned, unviable sta te-

owned enterpr ises are engaged in slow-mot ion bankruptcy by

sel l ing off the i r asse ts piecemeal in order to keep some of the i r

managers and staff drawing thei r salaries . Obviously, this

process cannot continue indefini te ly . The quest ion is , when more

and more of these employees lose the i r l ive l ihood wil l there be a

heal thy pr iva te sector which wil l be able to employ them? If

not , the rate of unemployment may become too much of a pol i t ica l

problem for any government to deal wi th.

Last ly , the resolut ion of the confl ic ts be tween the state and

sta te-owned enterpr ises lef t over from a former era can be

problemat ic dur ing the processes of transformat ion and





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Documents

The State & SOEs in Hungarian Privatization (PCEE 21, 1992) Gyorgy Holló