Russia's Voucher Privatization - The Tontine Coffee-House

When the Soviet Union collapsed in 1991, the abandonment of socialism in its former republics accelerated. In Russia in particular, industries were privatized at a breakneck pace. At first, this was done by so-called ‘voucher privatization’ where shares were purchased by ordinary people using vouchers distributed to almost all Russian citizens. One might expect such a program to result in widely distributed control of former state-owned enterprises. However, managers who knew their firms better than anyone else and bankers whom the almost bankrupt state desperately needed to court ended up with outsized control over Russian industry. Whatever its hopes, voucher privatization, and even more questionable schemes that followed, clearly went bad.

Russia in the 1990s

In 1990, the Soviet Union was on the verge of collapse. Mikhail Gorbachev was still General Secretary of the Communist Party and President of the Soviet Union but was walking a tightrope between two unreconcilable factions. Gorbachev himself was a reformer, but a cautious one. He favored some decentralization but also preservation of the USSR. He neither sought to maintain socialism as it existed then nor did he embrace capitalism. As such, he found himself caught between communist hardliners who wanted to preserve socialism and ‘liberalizers’, like the future Russian President Boris Yeltsin.

Gorbachev was unable to maintain the balance he sought and the divide between the hardliners and liberals erupted almost into a civil war. In 1991, a coup attempt by the communists failed, tilting the balance of power decisively in the liberals’ favor. The result was the breakup of the USSR, Gorbachev’s resignation, and the abandonment of socialism in Russia. Yeltsin went about putting Russia firmly on the path of rapid transition to a market economy. He installed Anatoly Chubais as minister for the Management of State Property (GKI). Chubais led a privatization scheme to dismantle the complex of inefficient state-owned enterprises (SOEs) bequeathed to the Russian state by the USSR.

Vouchers

The approach to privatization in Russia made use of vouchers given to ordinary citizens which they could then use to purchase shares in the SOEs. Though Yeltsin’s reforms were contentious, voucher privatization was initially welcomed by most of the public. When it came to restructuring the fiscally unsustainable state, privatizations were the only step that didn’t directly harm ordinary people, unlike tax increases, spending cuts, monetary tightening, or the loosening of price controls. By offering shares in privatized companies at low or no cost, the process seemed a boon to the average Russian.

The first step in privatizing Russia’s SOEs consisted of reorganizing them as corporate entities. Gorbachev had already sought to give managers more autonomy over their firms. Now, companies were formally reorganizing into western-style joint stock companies with all the accoutrements of capitalist enterprises such as corporate charters and boards of directors. Then, in 1992, Russians were offered privatization vouchers for a small 25-ruble fee. The vouchers had a 10,000-ruble face value so the vast majority of people paid the fee to acquire them. The vouchers were negotiable securities, meaning they were tradable on a secondary market, and each expired at the end of 1993. This was privatization at a breakneck pace.

As negotiable securities, the vouchers traded on dozens of exchanges across Russia. Indeed, confidence in the privatization program could be tracked in voucher prices. For example, in the months after their introduction, they traded at roughly half of face value as the future of the economic reforms and privatization policies looked uncertain. However, after Boris Yeltsin won an April 1993 referendum that was essentially a public vote of confidence in his presidency, prices rose back up to face value.

So far, the scheme seems relatively simple; people were given vouchers they could trade in for stock themselves or sell to a third party who might redeem them for stock later. That said, the exact manner in which firms were privatized varied as workers and managers at the SOEs were given some choices in how their employers would be sold off. In some cases, minority ownership in SOEs were given to workers for free. In other cases, managers and workers could buy stock at 1.7 times the July 1992 book value of the companies’ assets. However, given the high inflation, this was an out-of-date valuation and was thus essentially a giveaway as well.

Depending on the approach chosen by workers and managers of a firm, anywhere from 25% to 50% was given to these insiders. The state often retained up to a 40% stake in the businesses even after this first round of privatization in 1992-93. In a typical privatization, a small number of shares, around 5% of the total, were sold for cash, the proceeds of which funded the program. This left up to a 30% stake in privatized firms for those purchasing with vouchers in an auction format.

The net results of this first round of privatization were remarkable in multiple respects. First was the proportion of industry privatized. Already by September 1993, not even a year into the voucher privatization program, more than 20% of Russian industrial workers were employed by private firms. By the next year, roughly 15,000 firms had been privatized using vouchers. Second, these firms tended to be sold for very little. Backing out the valuations implied by these voucher purchases leads to an estimate of the aggregate value of all Russian industry in the neighborhood of $5-10 billion, an incredibly small fraction of Russian GDP (see Boycko et al. under ‘Further Reading’ below). These assets were essentially being given away.

Oligarchy

Whatever its outcome, the voucher privatization program seems like it should have led to widespread ownership of the former SOEs. After all, substantial stakes were split amongst these firms’ workers and much of the rest of the ownership was given to the public at low cost. However, the oligarchical nature of Russian industry today is a sharp contrast to this vision. There are several reasons for this, many tied to the nature of a second round of privatization conducted later in the decade.

Even under the voucher privatizations of 1992-93, managers often ended up with outsized control of the more valuable companies sold off. This primarily happened for two reasons. To start, managers usually had a superior knowledge of their firms and others in their industries than workers or outside investors could possibly have in such a nascent market system. Only managers could identify value from ruin. Second, it didn’t hurt that some had the benefit of riches they had embezzled from their firms during the chaotic preceding years and, as was mentioned earlier, many firms were sold for next to nothing. Take the example of Gazprom, Russia’s natural gas monopoly. It was sold for $250 million in vouchers in 1994; just two years later its shares traded in the US at a valuation of close to $37 billion.

However, the minting of Russia’s oligarchic class was mostly enabled by a later stage of the privatization of the country’s industry, under the ‘loans for shares’ program. Enacted by Yeltsin and Chubais, the loans for shares scheme was a response to Russia’s deepening fiscal crisis. Under the program, shares in twelve SOEs were used to secure a combined $800 million in loans. These firms were largely engaged in the export-dependent oil and metal industries, suffering through an era of low prices for their production. In the end, the government was not in a position to repay any loans and so the creditors, largely politically well-connected bankers, got to keep the shares.

The concept of a fiscally strained state borrowing against its largest assets, the shares of SOEs in the case of Russia, might not seem too problematic and, in and of itself, it perhaps wasn’t. However, the auctions whereby the shares were valued were often rigged. For example, in late-1995, the auction to loan money against a 40% stake in Russia’s fifth largest oil company, Surgutneftegaz, was conducted in a remote Siberian city whose airport inexplicably closed just before the auction. Only two bidders managed to show up. In many other cases, filings required from would-be auction participants were rejected for dubious reasons.

In the case of Surgutneftegaz, the government’s 40% stake was valued at $88 million, commensurate with a valuation of the entire firm of $220 million. Just two years later, following an initial public offering, Surgutneftegaz was worth around $6 billion; however, prices for the oil it sold had risen little in that time. Thus, many argue that not only were state firms being sold for substantial discounts as a giveaway to allies of the government in power but that this scheme enabled the creation of Russia’s oligarchic elite. Indeed, take the example of the now émigré Mikhail Khodorkovsky who acquired Yukos, one of Russia’s largest oil producers, for just $300 million through the program.

Alternatives

Those who enjoy contrasting the mixed success of Russia’s transition to capitalism against the more gradual approach undertaken by China often highlight the differences in their pace. In Russia, the breakneck pace of privatization is often recounted as having been necessitated by its shaky political foundation. While they were often seen as being better than a return to communism, Yeltsin and his reforms were not popular with many. The public’s faith in the state’s ability to carry out the reforms was always in doubt.

In the leadup to Yeltsin’s reelection, Anatoly Chubais, in crafting these policies, may have been seeking the political support of the oligarchs enriched by privatization. Indeed, many of them owned influential media assets. Consider that in 1996, the year Yeltsin was reelected with 55% of the vote, Gazprom was a minority owner of the television network NTV and even co-owned what had been the official newspaper of the Communist Party’s youth organization which, by the 1990s, became one of Russia’s more widely read papers.

The list of alternative approaches does not stop with the gradual transition undertaken by China. Other Central and Eastern European nations also transitioned away from communism at a similarly fast pace as Russia, but some did so with schemes that allowed the proceeds of privatization to be spread more widely and without creating the same oligarchic class. For example, in Poland, mutual funds were established to hold shares of state-owned enterprises. These were often managed by professional portfolio managers from abroad. In Poland, people traded in their vouchers for shares in these “National Investment Funds” and not shares in the individual former SOEs themselves.

Lesson

Whatever the missed opportunities, Russia today is among the richer of the ex-Soviet republics. However, it is also a nation where the fortunes of its industry seem quite detached from that of its people. In Russia, industrial power is consolidated in relatively few firms owned by individuals whose most important relationship is with the country’s political leadership. The history of how this came about is rooted in the way in which the privatization of industry was achieved more than two decades ago.

More from the Tontine Coffee-House

Read about another country’s fraught transition to capitalism, that of Albania. Also learn more about oil’s role in ending the Cold War.

Russia’s Voucher Privatization