Privatization in Bulgaria in the first years of the economic transition

Photo: burgascity.com

Following the fall of the Berlin Wall, the Eastern Bloc countries undertook a series of radical reforms with the ambition to make the transition from planned to market economy in the most effective manner. The main challenges faced as part of the process, were to achieve macroeconomic stability, to liberalize their prices and markets, to build an institutional and legislative framework for a market economy and to privatize state-owned enterprises.

Since state-owned enterprises (SOEs) accounted for the majority of the economic activity in the countries of the Eastern Bloc, their privatization is undoubtedly one of the key stages in the transition to a market economy. In the case of Bulgaria, it is also one of the most controversial aspects of the transition, and the way it has been implemented, continues to be a subject of discussion of politicians and other public figures.

Nearly three decades after the start of the process, the issue of whether and why the Bulgarian privatization has failed, compared to the one carried out in other countries in Central and Eastern Europe, remains to some extent open.

The economic context in Bulgaria

In the 1970s and 1980s the Bulgarian economy is strongly linked with the COMECON countries – accounting for as much as two-thirds of the country’s trade volume , with exports to the USSR alone, making up half of the total exports[i].

This made Bulgaria one of the countries most economically tied to the Eastern Bloc. In addition, trade with the CMEA countries was taking place in non-market conditions. Bulgaria was exporting large quantities of electronics and machinery for which it was receiving raw materials[ii], such as oil, which was in turn, processing and exporting on the international markets in order to obtain “hard currency”.

This type of barter system was creating significant imbalances as it was causing an inefficient distribution of investment resources. After the collapse of the Bloc, the country lost its main export markets and its products were uncompetitive in the West, and as a result its exports dropped by 34.6%[iii]. In the same time, the prices of the raw materials imported by Bulgaria jumped to market levels, leading to a large balance of payments deficit and increasing inflation levels.

The country was, thus, unable to meet its foreign debt payments and in March 1990 the parliament imposed a moratorium on payments on its external debt and thus, severely limiting its possibilities for external financing and foreign investment.

The theoretical rationale for privatization

Following the collapse of the socialist system and the start of reforms in the CEE countries, processes in the region became a popular research topic by a number of economists and scientists from leading international institutions such as the World Bank, the IMF and the OECD.

Theory suggests that privatization of state owned enterprises would allow the economies in the region to develop competitive enterprises by raising investments, applying good managerial and technological practices and carrying out the necessary organizational restructuring.

Indeed, in an overview of academic research conducted on the topic, a 1999 publication of the IMF shows that a large part of the academic research on privatization in the region demonstrate that privatization has brought significant benefits to the CEE countries: increased productivity of enterprises by 3 to 5 times, higher labor productivity, increased production efficiency, and more .

Overview of the different privatization methods applied in Central and Eastern Europe

The two main methods of privatization applied by the Central and Eastern European countries were:

  • Market privatization – a gradual privatization by selling state assets to strategic investors.
  • Mass privatization – transfer of ownership of state-owned enterprises to employees, management buyouts or through specially designed investment funds.

The privatization strategies in the different countries were largely determined by the specific conditions of those countries as well, by the desired balance between speed, attraction of investments, government revenues and social justice. Different countries in the Central in Eastern Europe region applied different degrees of mass and market privatization.

In Hungary, which suffered from a relatively large external debt, generating government revenue was the main priority, and large state companies were acquired by foreign companies. The primary method of privatization was direct sale, which allowed the country to attract significant foreign investment. The Czech Republic, on the other hand, demonstrated a preference for a swift process as well as ensuring social justice. The country applied the voucher method of mass privatization, making every citizen a shareholder in state companies, but unfortunately, mass privatization did not bring the desired results as the assets were concentrated into a few individuals.

In the case of Estonia, the country applied a hybrid model combining market and mass privatization. In order to attract foreign capital and know-how practices, while ensuring a socially adapted approach, the government decided that 50,1% of the capital of state enterprises would be sold to strategic investor and the remaining part distributed to Estonian citizens in the form of vouchers.

In Poland, the privatization was implemented in several stages using various instruments. The first stage, initiated in 1990, targeted SMEs and was prioritized polish citizens and particularly employees. In the second stage, the government sold off large state-owned enterprises using five different methods: direct sale to foreign investors, leveraged buyouts, sale on the capital markets, sale of specific assets and sale to specifically designed investment funds.

The pace of the Bulgarian transition and privatization

In the case of Bulgaria, the process of privatization was proceeding much slower than in the CEE countries. As of 1996, the overall progress of the Bulgarian economic transition was limited. A report by the European Bank for Reconstruction and Development on the pace of reforms in the countries of Central and Eastern Europe identifies the Czech Republic, Hungary, Poland, Slovakia, Slovenia and Croatia as relatively advanced in the reform process, while Bulgaria was placed in a lower category of countries an intermediate stage of the reforms along with Romania, Macedonia, Albania and Russia[iv].

Part of privatized enterprises in 1996

Czech Rep.

Poland Hungary Romania

Bulgaria

Part of privatized enterprises (OECD[v])

87%

55% 85% 20%

15%

Part of the privatized industrial companies in terms of a number (World Bank[vi])

89%

61% 67% 15%

8%

Part of privatized industrial companies in terms of production (World Bank)

93%

60% 65% 12%

7%

At that stage, the state continued to have a significant role in the economy. Although the country had already carried out a series of reforms and had the required institutional and regulatory framework, the successive governments did not follow a consistent policy and as a result in the mid 1990’s, the economy was still largely influenced by the state and the part of the private sector in the GDP was among the lowest in Europe.

Source: EBRD

The delay of the privatization had negative effects on the efficiency of the Bulgarian industrial sector. According to a 1995 study of the World Bank, Bulgarian industrial sector suffered one of the highest levels of bad credit[vii]. What is more, state-owned industrial firms had no incentive to make significant capital expenditures and had the lowest levels of investment in the region.

Source: World Bank Technical Papers

The lack of investments and poor management in the SOEs and the delay of their privatization, had significant cumulative consequences on the economy. While Hungary, the Czech Republic and other countries from the region were attracting major strategic foreign investors, in 1995, such companies were virtually absent in Bulgaria, leaving unable to benefit from the boom if FDI flowing into the region until the introduction of the reforms in 1997.

 

Source: WIFO – Austrian Institute of Economic Research

Eventually, the financial and economic crisis of 1996, served as a trigger that allowed to reach the social and political consensus necessary to launch the privatization program of a thousand State-owned enterprises, representing 15% of the total state-owned assets. The privatization was carried out through a distribution of vouchers but was highly controversial because of a lack of transparency and clearly defined rules. As a result, small shareholders did not receive any ownership or dividends.

The voucher approach thus tarnished the image of privatization among Bulgarians and led to irreversible loss of confidence as it failed to ensure both social justice and the development of efficient and competitive enterprises. The unsatisfactory end result also demonstrated the disadvantages of the method of voucher privatization, as opposed to the sale of state assets to a strategic investor, or the Estonian hybrid privatization model.

The reasons behind the delay of the privatization

The lack of strong political will among the successive Bulgarian governments in the beginning of the transition can be identified as the main reason behind the delayed privatization. In addition, the sharp drop in the standard of living decreased the public support for market-oriented reforms and provided the socialist government of Zhan Videnov with a mandate to conduct a socially-oriented policy and a gradual economic transition. Thus, the government of BSP (Bulgarian Socialist Party) reverses some of the market reforms – the part of the government-controlled prices increased from 18,9% in 1994 to 52,4% in 1996[viii].

Another major reason for the lack of public support for market reforms was the negative perception and general distrust for the privatization because of the strong role of criminal organizations and individuals with strong political ties in the process.

The legacy of the first years of Bulgarian privatization

The privatization is one of the key components of the Bulgarian transition to competitive market economy. Unfortunately, this process was extremely slow to start because of the lack of determination and courage among the political class as well as the lack of public support.

The resulting price is high – Bulgarian taxpayers had to sustain loss-generating public companies for years. The accumulation of debt and the decision of the government to not let insolvent companies go bankrupt eventually, led to the financial collapse of the country during which hundreds of thousands lost their savings. When the privatization did eventually start, it was conducted in a context of weak institutions and a lack of functioning capital markets. As a result, the privatization a few well-connected organizations benefited – leaving the population disillusioned with the effects of market economy on the country’s prosperity.

What is more, the failure of achieving a successful privatization is a missed opportunity for Bulgaria to benefit from the entry of international companies that could have introduced technological and managerial know-how and leading business practices. Instead, the vacuum has been filled by oligarchs with close connections to the government, occupying key sectors of the economy. Even today, some of most prominent businessmen in the country have dubious past, consistently avoiding talks about the origins of their fortune. The effects of privatization go far beyond the economy alone and affect society in different intangible ways. The strong presence of such organizations in the economy also undermines the belief among Bulgarian society entrepreneurship, fair competition and the market economy as a whole.

Author: Nikola Apostolov
Email: nikola.apostolov@hec.edu
2018 Millennium Club Bulgaria

References:

[i] Анатомия на прехода (2004). Институт за пазарна икономика., София. 4-10.

[ii] Wight, Jonathan, and M. Louise Fox (1998). Economic Crisis and Reform in Bulgaria, 1989-92. Balkanistica 11University of Richmond, 127-46.

[iii] Анатомия на прехода (2004). Институт за пазарна икономика., София. 1-5.

[iv] European Bank for Reconstruction & Development. (1996, November 01). Transition Report 1996: Infrastructure and Savings – Economic Transition in Europe and the Former Soviet Union – Transition Report.

[v] Trends and policies in privatisation/Tendances et politiques des privatisations (1996). Paris : OECD.

[vi] Barr, N. A. (1996). World development report 1996: From plan to market. New York : World Bank.

[vii] G., Anderson, R. E., Claessens, S., & Djankov, S. (1997). Privatization and restructuring in Central and Eastern Europe. World Bank Technical Papers. doi:10.1596/0-8213-3975-3

[viii] Анатомия на прехода (2004). Институт за пазарна икономика., София. 10-15.

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