Outsourcing Privatization In Ukraine To Attract Capital And Raise Efficiency

 Historically, Ukraine’s proceeds from privatization have been much lower than expected because the best enterprises were sold at low prices to oligarchs close to the government, writes Luc Vancraen, a Kyiv entrepreneur in his VoxUkraine op-ed.  Creating an independent foreign-managed privatization body will raise confidence of investors and attract capital while at the same time reducing government sector and thus raisin efficiency of the economy, Vancraen believes.

Ukraine’s excessive government sector is a Soviet legacy that has prevented the country from growing a competitive market economy, where private enterprises and prosperous citizens are able to support efficient government services through tax contributions. Ukraine never had the courage to drastically migrate away from bloated government services and thousands of government companies. It is estimated that about 3500 state-owned companies exist. Many of these companies are in a very bad shape after years of bad management. Only those with clear economic potential have been privatized.

We believe that a radical reduction of the state sector is a key to raising the overall efficiency of Ukrainian economy. This reductions should proceed along two lines. First, reduce the number of civil servants (i.e. people who regulate different spheres of people’s life – perhaps everyone will agree that this regulation is way too excessive). Second, reduce the share of government ownership in the economy – it is shown by multiple studies that private companies are usually more efficient than state-owned ones. One way to avoid the vested-interest problem that hindered privatization process before is outsourcing of the state function that is currently assigned to the State Property Fund, i.e. managing and selling of state-owned enterprises. A similar thing was done in Germany over 20 years ago.

To migrate away from a state run economy after the German unification, Germany set up the Treuhandanstalt (“Trust agency”). It was the agency that privatized the East German enterprises. The Treuhandanstalt oversaw the restructuring and selling of about 8500 state-owned companies with over four million employees, as well as much other state property – land and forests, housing etc. At that time it was the world’s largest enterprise, controlling everything from steel works to the Babelsberg Studios.

Over the course of 4 years it privatized these companies, and 2.5 million employees of state-owned enterprises (out of 4m in total) were laid off. One of the distinguishing features of the Treuhand was that it was actively involved in the restructuring of the companies prior to the privatisation. At the time the Treuhand was criticised for cutting too hard too fast. But twenty years later with hindsight we see that systematically those economies that restructured their government companies fast have outperformed those that lacked this courage.

In Ukraine, about 2 million  people are still employed in the government sector. See table 1.

Total number of employees, without those employed in small business, is 10.2 million or almost 50% of total employed population. These 10.2 million employees are distributed as follows:
58.6%	work in private or semi-private companies or cooperatives
19.3%	work in the state sector, namely
6.5%	work in executive power bodies (of them 433 thousands or 4.2% are civil servants)
3.5%	work in state-owned enterprises
9.3%	work in state organizations (these include educational, scientific, healthcare and cultural institutions)
22.1%	work in the communal sector, namely
5.4%	work for local governments
3.6%	work for communal-owned enterprises
13.1%	work for communal organizations (again, mostly education and healthcare)

To restructure and privatise government companies based on the Treuhandanstalt experience, a lot of money will be needed. We propose to request at the donor conference the funding of a privatisation fund to privatize these government companies. International donors could provide  €1 billion grants and €1 billion in loans to this fund (see Table 2 for details). The approach of the Treuhand suggests that effective corporate control structures can be created without the adequate managerial resources being available domestically. Future privatization revenues can sustain the fund. Foreign donors will get seats in the board of this restructuring/privatization fund based on their contributions. The fund should be managed outside of the Ukrainian government. If at the end there are profits left, these should go to strengthening the capital of the National Bank of Ukraine.

Ukraine has a terrible track record on privatizations, and this fund can avoid the mistakes of the past where profitable companies were sold for obscure amounts to a few oligarchs with the right political connections. An international privatization fund will give foreign investors the confidence that an enterprise they buy is “clean” and that their investment will be protected from predatory schemes.

We should be realistic. The best companies are already gone and most of what is left will have to be closed down. Still, often these companies have real estate that could be used to help pay for the restructuring or to grow new business. A part of the real estate could be used as company centres where Ukrainians can start their own company and rent space at very affordable rates. This should allow easy creation of new production companies that can service the EU market with low cost labour intensive products that are typically coming out of Asia at this moment. Ukraine as a EU neighbor has a clear transport advantage over Asia.

The restructuring fund should also help create new jobs by helping to fund up to 10.000 Ukrainian start-ups in these company centres.  Ukrainians have plenty of ideas but lack capital and the collateral to obtain loans to get started. The company centres set up through the fund should fund the purchase of investment/production equipment up to an average of €50.000 per new company. Until the investment goods are fully paid down they remain the property of the company centres. These start-ups have to service partially the EU or foreign markets and should help generate hard currency for Ukraine through export.

The fund could provide management to evaluate the viability of the business ideas. The management of these company centres should be  done by recently retired managers from the EU & US who will work for expenses paid. They will bring in a wealth of experience and the right connections for export opportunities.

We can realistically expect that over a half of the people in these government companies will become redundant. Those who end up in the fund and who are deemed not needed will be fired and will get six-months-salary exit payments. After these six months they will be entitled to one year of unemployment benefits. The fund should refund the government for those ending up in unemployment and should provide free retraining to these people to enhance their chances on the private labor market. This means those fired will have effectively one and a half year to migrate to the private sector. They only get this money provided they stay in Ukraine and they are not rehired by the government for seven years.

Firing of redundant workers (exit payments, unemployment benefits, retraining)	€ 5000 per person * 200 000 people		€ 1 billion grant
Funding new companies (start-ups)	up to € 50 000 per company * 10 000 companies		up to € 500 million loan
Fund managementInvesting into modernization of government companies that cannot be privatized and into energy saving technologies	150 000 employees remain		up to € 500 million loan plus  proceeds from privatization

A Treuhand style approach through an international fund puts the restructuring outside of the government and will make it a lot easier to execute politically.

Most of the employment will have to come from new business that can only grow if the government puts its focus on creating a fair and competitive economic environment based on the rule of law. To establish that environment is already a massive task, and managing or restructuring companies would be a detraction of the government from the core task of creating economic freedom and a supportive administration in a new Ukraine.