The Politics of Privatization: Wealth and Power in Postcommunist Europe 9781685854362

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The Politics of Privatization

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The Politics of Privatization Wealth and Power in Postcommunist Europe

John A. Gould

b o u l d e r l o n d o n

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Published in the United States of America in 2011 by Lynne Rienner Publishers, Inc. 1800 30th Street, Boulder, Colorado 80301 www.rienner.com and in the United Kingdom by Lynne Rienner Publishers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU © 2011 by Lynne Rienner Publishers, Inc. All rights reserved

Library of Congress Cataloging-in-Publication Data Gould, John A. The politics of privatization : wealth and power in postcommunist Europe / John A. Gould. p. cm. Includes bibliographical references and index. ISBN 978-1-58826-758-0 (hc : alk. paper) ISBN 978-1-58826-783-2 (pb : alk. paper) 1. Privatization—Europe, Eastern. 2. Privatization—Europe, Central. 3. Europe, Eastern—Economic policy. 4. Europe, Central—Economic policy. 5. Post-communism—Europe, Eastern. 6. Post-communism— Europe, Central. I. Title. HD4140.7.G68 2011 338.437'05—dc22 2010049166

British Cataloguing in Publication Data A Cataloguing in Publication record for this book is available from the British Library.

Printed and bound in the United States of America The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Printed Library Materials Z39.48-1992. 5 4 3 2 1

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Contents

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Acknowledgments 1 Introduction

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2 The Command Economy and Its Legacies

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3 Postcommunist Privatization and Politics

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4 Privatization Design in Czechoslovakia, 1990–1992

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5 The Politics of Privatization in the Czech Republic

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6 The Politics of Privatization in Slovakia

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7 Postprivatization Entrepreneurs and the Political Economy of Ukraine

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8 The Political Economy of Regime Change in Serbia, Georgia, and Azerbaijan

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9 Beyond Creating Owners

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List of Acronyms Endnotes Bibliography Index About the Book

189 191 209 229 247

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Acknowledgments

incurred many debts while writing this book. Sources of funding and support include the Institute of War and Peace Studies and the Chazen Institute at Columbia University, the Institute of International Education, the East European Institute of the Woodrow Wilson Center, the Robert Schuman Centre at the European University Institute, the International Research and Exchanges Board, and the Social Sciences Executive Committee and the Dean’s Office of Colorado College. I would in particular like to acknowledge the comments and insights of my students at Colorado College, including Meaghan Cooper, Nicole Gruttadauria, Mayya Komisarchik, Paul Mandelson, Edward Moe, and Spenser Shadle. In addition, I could not have written two chapters of the book without the hard work and intelligence of two student collaborators, Yaroslav Hetman and Carl Lee Sickner. I would also like to thank the many colleagues who contributed at some point in important ways. These include Hilary Appel, Mark Blyth, Valerie Bunce, Jan Drahokoupil, Michelle Egan, Sharon Fisher, Zsolt Gál, ´ ubomíra Hromková, Paul Anna Grzymala-Busse, David Hendrickson, L Kubicek, Juan Lindau, Darina Malová, Vladimir Mykhnenko, Mikael Olsson, Mitchell Orenstein, Esther Redmount, Marek Rybá¸r, Andrew Schwartz (1957–2004), Jonathan Stein, So¸na Szomolányí, James Thompson, Milada Vachudova, Jan Zielonka, and especially Kevin Deegan-Krause and Timothy Haughton, whose friendship and collegiality have been so important in many stages of the development of the book. In addition, I thank the hardworking anonymous reviewers and editors at Lynne Rienner Publishers. I would also like to recognize the late Karen Ballentine (1961–2010),

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ACKNOWLEDGMENTS

who was not only a dear friend to me and my family, but an absolutely essential colleague in helping me complete this manuscript. I miss her wonderful sense of humor, relentless skepticism, and enduring friendship. That I cannot address all the concerns raised by friends, colleagues, and reviewers concerns me deeply—all the more so because their insights and suggestions have already made this a much better work. The decision to freeze the process of judgment and reflection into a set text is always a difficult moment, but in this I am guided by my friend Tim Haughton: “At times it is important to publish and contribute to the debate” (2005: x). I have adopted some of the work in this book from previously published articles. Chapter 7 builds from an article I coauthored with Yaroslav Hetman, “Market Democracy Unleashed? Business Elites and the Crisis of Competitive Authoritarianism in Ukraine,” Business and Politics 10, no. 2 (August 2008): 1–33. Chapter 8 adopts the empirical case studies from my work with Carl Lee Sickner, “Making Market Democracies? The Contingent Loyalties of Post-Privatization Elites in Azerbaijan, Georgia and Serbia,” Review of International Political Economy 15, no. 5 (Fall 2008): 740–769. I bear full responsibility for the alterations and additions to each. Finally, I would like to thank my parents, Sharon and Bill Gould, and my children, Lukaš and Marek, for their sustaining love. I owe my greatest debt of gratitude and dedicate this book to Simona Gould. Her patience, love, and deep insight into all things postcommunist made this work possible.

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1 Introduction

The violence and injustice of the rulers of mankind is an ancient evil, for which, I am afraid, the nature of human affairs can scarce admit of a remedy. But the mean rapacity, the monopolizing spirit of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind, though it cannot perhaps be corrected may very easily be prevented from disturbing the tranquillity of anybody but themselves. —ADAM SMITH, WEALTH OF NATIONS

rivatization, or the transfer of economic assets from state to private hands, is based on the usually justified assumption that private owners will appoint better managers than governments. When communism fell in Central and Eastern Europe in 1989, there was a clear need for privatization. Europe’s communist governments had nationalized most of their countries’ economic assets. In Czechoslovakia, for example, state-owned enterprises accounted for virtually all official economic activity. Many of these firms suffered from poor state planning and perverse market controls; some firms produced products that were worth less than the combined cost of labor, energy, and materials that went into their production. In addition, state ministers, managers, and employees excelled at expropriating enterprise resources for their own use. Such theft aggravated the firms’ crises and drained the state budget. Replacing state bureaucrats with private owners as part of a thorough program of market reforms promised significant improvement. Private owners would not long tolerate managers who subtracted value from produc-

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tion. Ideally, private owners would restructure the firms to deliver a profit. Many would fail, but in failing they would release valuable labor and capital to be picked up by other entrepreneurs. Eventually, this “creative destruction” would lead to a more productive economy—one that would produce better quality products, in greater quantities, with the country’s available resources (Schumpeter 1975: 82). Advocates also expected privatization to produce important political change. New owners would soon understand that the old political and economic way of doing things diminished their bottom line. They would demand laws that protected their property; they would demand judges that enforced the law rather than the whim of corrupt officials or political strongmen; they would seek the right to replace corrupt or antibusiness bureaucrats with ones who promoted economic freedom; they would fight for their right to organize themselves to lobby for a freer political and business environment. Most importantly, in countries where former communist authoritarians still held sway, a private business class would demand political elites who would behave themselves—nurturing the business environment, rather than preying on it. Economic reforms like privatization would thus help drive liberal political change. This was a good reason to privatize even under undemocratic or corrupt conditions (Boycko, Shleifer, and Vishny 1995: 154; Shleifer and Treisman 2000: 38). This book takes a skeptical look at this prescription. Its origins are in an assassination that occurred in 1996 outside my apartment in Slovakia as a political battle over state property and democracy was reaching its peak. Since late 1993, Slovakia’s president, Michal Ková¸c, had been speaking out against the increasingly authoritarian policies of Vladimír Me¸ciar, Slovakia’s prime minister. Chief among his accusations was that Me¸ciar was using the privatization process to enrich friends and associates. Me¸ciar was looking for an opportunity to embarrass and discredit the president. In August 1995, members of the Slovak Information Service (SIS) kidnapped President Ková¸c’s son, Michal Ková¸c Jr., and left him on the Austrian side of the border. He was alive, but had passed out after being beaten, tortured, and forced to drink a bottle of whiskey. Ková¸c was wanted for questioning in Germany in relation to a fabricated financial scandal. His kidnappers apparently hoped that the Austrians would deliver him to the German authorities. Instead, the Austrians returned him to Slovakia, where his abduction provided additional fuel to Me¸ciar’s opponents. On April 29, 1996, Róbert Remiáš was returning from a meeting with the editor of a leading newspaper when his BMW exploded several hundred meters from my apartment. Remiaš was the friend and confidant of a former SIS agent who had worked with the team to kidnap the president’s

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son. The agent had told his story to the police and had gone into hiding in Hungary. Remiáš was now serving as his go-between. As evidence of SIS involvement began to mount, Me¸ciar’s government squashed the investigation—replacing three investigators before finding one who suspended the inquiry into the SIS link. The new investigator concealed evidence that 150– 200 grams of Semtex had ignited the car’s propane tank. Now on the defensive, the SIS launched a campaign to show that Ková¸c Jr. had arranged for his own kidnapping (Deegan-Krause 2006: 49–50; Williams 2001: 130– 140). Ironically, on the Friday evening when Remiáš’s exploding car rattled my windows, I was reading an exciting new book by several leading economists who had assisted with Russia’s troubled privatization program. I had only minutes before read the line: “the principle objective of reform was . . . to depoliticize economic life” (Bocyko, Shleifer, and Vishny 1995: 11). In particular, the authors felt privatization would perform this trick by cutting ties between politicians and enterprise managers—enabling the latter to seek profits for firm owners, rather than provide jobs and other perks to disgruntled voters. Remiáš’s murder prompted me to ask whether these mostly well-meaning economists were missing a crucial aspect of the privatization story. Privatization is not expected to be associated with assaults on democracy, kidnapping, and murder. Economic textbooks rarely discuss its dark side. Yet, politically, postcommunist privatization is a high-stakes game that distributes wealth to some people and not others. With such enormous prizes, many postcommunist politicians preferred to win by cheating at the rules. In addition, privatization programs were launched in postcommunist Europe while these rules were still emerging. Where politicians felt that more democracy would deprive them of control over the privatization process, they had an incentive to resist it. More broadly, privatization helped reveal the important role liberal politics played in Europe’s postcommunist economic transformations: a state’s degree of political liberalization was an important predeterminant of the direction and pace of economic reform. Liberal politics came first; in their absence, liberal economic reforms were unlikely to follow (Hellman 1998; IMF 2003: chap. 3). Where communist-era political elites did not face a robust challenge from opposing parties and civil society, the incumbents usually controlled the introduction of postcommunist political institutions. This allowed ex-communists to limit and subvert economic reforms and provided them with opportunities to benefit at everyone else’s expense. Nor was there any political mechanism to release the grip ex-communists had on political and economic power (Vachudova 2005).

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Control over privatization was perhaps the most important stake in this game. Where society exercised only a weak political check on ex-communist politicians, the political elite could limit or manipulate others’ access to the privatization process. The result was that much of postcommunist Europe’s wealth and power concentrated into the hands of small groups of the politically connected (Hoff and Stiglitz 2005). Once these political and economic insiders became owners, they often did not behave as the economists had hoped. Privatization often came before institutional structures were in place that would force the new owners to behave themselves. Worse, reformers’ belief that private economic agents would subsequently demand these structures led economic reformers to ignore the need for legislation to create them before or during early privatization efforts. In the meantime, the postprivatization context was rarely as rosy as economists envisioned. Rather than revitalize their enterprises, new owners often stripped out their value. Rather than lobby for reforms enhancing economic competition, they frequently lobbied for monopolies. Rather than demanding law-abiding politicians, they all too often collaborated in political corruption. In short, while privatization was supposed to produce entrepreneurs who would push for democracy and efficient markets, the combination of privatization and illiberal politics spawned oligarchs who fought against such improvements. Where economic reforms did emerge, it was usually because some form of economic dysfunction was starting to hurt the oligarchs’ interests. Privatization arguably worked better in more democratic postcommunist countries. Liberal politics gave privatization processes more legitimacy. Although highly resented by many, new owners were less likely to be threatened by democratic institutions. In addition, while policymakers often bungled aspects of privatization, relatively robust democratic institutions ensured that the beneficiaries of the privatization errors were eventually exposed and major policy mistakes addressed. Although privatization in democratic countries also concentrated wealth and produced corruption, a more competitive political environment helped ensure that there were limits to what the winners could do with their wealth and power (Hellman 1998; Orenstein 2001; Vachudova 2005). Economists often assert that economic dysfunction is the result of a lack of skill and will among politicians. This book demonstrates, by contrast, that for many forms of economic dysfunction, there is a beneficiary kept in place by illiberal politics. Economic reforms help, of course, especially when they force private owners to earn a profit rather than to lobby for it. But where these beneficiaries remain in control, chances of getting

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meaningful economic reform are slight (IMF 2003: chap. 3). In postcommunist Europe, the best fix for economic dysfunction has proven to be more robust political competition. Unfortunately, political competition emerged in only a handful of postcommunist countries in the 1990s. In the majority, the collapse of communism did not effectively unseat the old order. Control over the political framework gave incumbents control over the privatization framework—a mechanism that politicians used to distribute wealth and power to themselves and their allies. The news is not all bad, however. Some observers initially feared the tight connection between wealth and illiberal power would become stable over time—an undemocratic equilibrium in which the interests of the newly emerged business class would prove permanently inseparable from the privileged and often oppressive control of its political patrons (Hellman 1998). As privatization advocates hoped, however, this arrangement proved to be quite fragile in a number of countries. Political strongmen in Slovakia, Croatia, Serbia, Georgia, and Ukraine found that oligarchs can be unreliable allies (Levitsky and Way 2002). During moments of greatest government weakness, important business actors often defected to oppositions that promised a more rule-governed political and economic environment. This observation provides us an opportunity to reconcile advocates of privatization with their critics. In the short run, privatization was indeed used by former communists and others to consolidate their control over the political and economic life of the country. In the long run, however, many privatization beneficiaries lent their support to movements promising democratic political change. Often, they defected because the regime had become so predatory that it left them no choice (Junisbai 2009). Other times, businessmen were simply seeking to hedge their bets during a crisis, hopeing to protect their interests should the new government win. Yet, as privatization advocates predicted, the temptations toward defection were also greater where private owners already had to produce a marketable product to survive (Wilson 2005). To the extent that previous economic reforms forced them to do this, economic reforms could be a force for political liberalization. Conversely, this defection temptation was weaker where the dominant business class remained dependent on political connections, rather than entrepreneurial skill, to generate a profit. It was weaker still where the regime further cemented elite loyalty through clan-based identity ties or lucrative oil rents. To the extent that a regime change threatens postprivatization elites’ access to policies that guarantee them earnings, they adhere to the regime or limit their defection to a strategic effort to preserve their perks should the opposition prevail.

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Outline of the Book

This book is for scholars and policymakers, but I would also like it to be accessible to my undergraduate students—the generation born after the fall of the Berlin Wall. So much of the work on the postcommunist period assumes a wealth of knowledge about communism and subsequent events that this generation has had no reason or opportunity to learn. With this in mind, Chapter 2 offers a brief schematic of the nature of communist-era political economy and a review of debates among economists on how to replace it once it collapsed. Chapter 3 develops the debate. It pays particular attention to privatization’s theoretical role in the economists’ broader vision for transitioning communism into capitalism, and it covers new ground by developing a theoretical response based in political competition theory. Chapters 4, 5, and 6 then turn to the rich empirical political story of privatization in federal Czechoslovakia and its successor republics. Democratic Czechoslovakia is a cautionary story: the design of its privatization framework reflected the relatively powerless position of communist-era managers and employees, but this did not mean privatization was well conceived. Chapters 4 and 5 will explore the political origins and ramifications of the privatization design choices made by Václav Klaus, federal minister of finance, and others. In his subsequent role as prime minister, Klaus benefitted from the privatization program and arguably some of its flaws. Given that many associated with the governing coalition benefitted from deficiencies in the program, correcting them proved difficult. Ultimately, necessary additional change required a change in government—a change made possible by the country’s comparatively robust political institutions. In Chapters 4 and 6, by contrast, we see how Me¸ciar, three-time Slovak prime minister, rose to power with the support of those who felt most threatened by Klaus’s federal privatization program. Me¸ciar is notorious for having pushed Slovakia’s democracy and market economy to the edge in the mid-1990s. The politics of privatization played a role. Whereas communistera managers and bureaucrats in the Czech Republic had been initially discredited by their close association with the communist regime, in Slovakia, the same sorts of people found an important resource in nationalist concerns that federal economic reforms like privatization were not appropriate for Slovakia’s somewhat more difficult economic challenges. Me¸ciar sympathized with these concerns and used them to strengthen his leadership over the movement for greater Slovak political and economic autonomy. After independence on January 1, 1993, Me¸ciar began to reorient Klaus’s privatization program toward a program of easy sales to his political allies. These controversial and clearly self-serving steps provided his

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opposition in the National Assembly, the press, and civil society with additional fuel for criticism. Me¸ciar’s parliamentary majority responded by concentrating power and disregarding democratic procedure to a point where the European Union (EU) excluded Slovakia from membership negotiations on political grounds in summer 1997. Me¸ciar’s closest privatization winners used the increasingly undemocratic climate to secure for themselves favorable economic policies that suppressed investment, undermined the financial system, and threw the economy into a deep imbalance. The government, meanwhile, attempted to hide its self-dealing behind a nationalist cover story about the patriotism of its supporters and the anti-Slovak designs of its critics. While privatization was not the only cause of the democratic and economic distortions in Slovakia from 1993 to 1998, it was certainly a contributing factor. Fortunately, the Me¸ciar era came to a swift close in 1998. An unprecedented 84.4 percent voter turnout and a unified opposition—including some important economic actors who were concerned about Slovakia’s weakening business prospects—forced Meciar and his allies into the opposition. While Me¸ciar-era economic distortions would take years to fix, and while the fixes were not without mistakes or scandals themselves, the democratic breakthrough of 1998 remains the seminal moment in the country’s postcommunist development. Slovak citizens had established their ability to hold their elites accountable for political and economic mismanagement. From Slovakia, Chapter 7 turns to Ukraine—a country whose postcommunist trajectory was brokered by former communists. Newly independent after the dissolution of the Soviet Union in 1991, Ukrainians had little say in the establishment of post-Soviet political institutions or economic policies. Ex-communist political elites managed the process and for most of the 1990s they did so in ways that allowed them to transform their privileged positions under communism into political privilege and often vast material wealth in the postcommunist period. Robust and competitive, Ukrainian politics was nevertheless mostly an elite-brokered fight between regional ex-communist elites and the occasional upstart over the wealth of the former Soviet republic. From 1994 until 2004, President Leonid Kuchma served as the elite’s chief broker, a position he managed with the assistance of regional power holders, a powerful and politically obedient presidential administration, a politically directed media, a diluted and personalized party system, managed elections, murder (allegedly state directed), and financial and physical intimidation. Privatization initially took a form that resembled the mass privatization policies designed by Klaus to do an end run around communist insiders. In practice, however, the politically connected manipulated the program from

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the start to ensure that they would retain control over assets. Private ownership of Ukraine’s industrial landscape initially did little to revitalize the economy. New owners stripped their enterprises or sought guarantees of profit through protectionism or favorable financial and commodity policies. For most Ukrainians, the result was a dismal decade of decline into deeper poverty. As Ukraine’s economy grew increasingly weak and vulnerable to external shocks, the country’s elite agreed to market reforms: first, in 1995– 1996, the stabilization of the currency; and second, in 1999–2001, the elimination of many of the major market distortions. The second round of reforms, under the leadership of ex-banker Victor Yushchenko, helped set the country on a path to recovery. As postprivatization entrepreneurs lost their protections and privileges, they had to restructure their firms to produce goods or services that the country and the rest of the world would buy. The timing was perfect as export markets for Ukraine’s primary industrial goods—particularly steel—drove robust growth for a solid five years. Yet, Prime Minister Yushchenko’s reform campaign struck at the vital interests of the country’s most important economic players—particularly in the coal and steel industries. While this sector’s main players favored a stateenabled industrial policy that improved their competitiveness, the policy relied heavily on large subsidies to the country’s ailing and costly coal sector. Steel-sector leaders also reinforced an illiberal political system in which they and other regional power brokers had asymmetric access to political information and power. As Yushchenko’s reforms began to threaten these arrangements, power brokers in steel and coal secured his removal—to be replaced a year later by one of their own. Over the next three years, tensions between the winners and losers of Ukraine’s political economy mounted, culminating in a fiercely contested presidential election in fall 2004. An opposition-led mass movement refused to acquiesce in a fraudulent election. As in Slovakia, postprivatization entrepreneurs lined up on both sides of the contest; Kuchma’s elite economic supporters did not offer a solid front. Some may have crossed “honestly” to promote an environment in which investment is protected, rather than discouraged, by the state. Others opportunistically crossed lines in hopes of getting a better deal with the new party of power; one suspects that a major concern was to ensure that cheaply acquired properties would not be reacquired by the state. By no stretch of the imagination did Ukraine’s business elite lead the democratic opening of 2004, also known as the Orange Revolution. At best, a subgroup of business leaders played a supporting role to a mass movement that sought political liberalization. At worst, business leaders stub-

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bornly clung to the Kuchma regime in an effort to retain their privileged access to state policies that fattened their bottom line. As in Slovakia, however, Ukraine’s chance to liberalize its political system came from a unified opposition backed by a mobilized and peaceful civil society. From Ukraine, Chapter 8 travels both east and south to look at the politics of privatization in Serbia, Georgia, and Azerbaijan. The three countries differ in theoretically interesting ways. First, Azerbaijan has the only resource-dominated economy in the book—its elites derive wealth primarily from access to state-directed energy resource rents. Second, Azerbaijan and Georgia share strong kin-based clan identities that can serve as an important organizing framework for economic policies like privatization. Serbia, by contrast, lacks both kinship distribution networks and energy resource rents. The three countries are similar, however, in that each was led by undemocratic postcommunist leaders who used the privatization process and economic policy to reward supporters and punish opponents. Each leader also attempted to remain in power through a fraudulent election leading to a regime crisis. In Azerbaijan, we see how the country’s main economic elites remained loyal to the regime throughout the contested 2004 presidential election and subsequent elections. I argue in Chapter 8 that the logic of democratic institutions was incompatible with a system of power based on the distribution of resource wealth through tight kinship and business networks. In resource-poor societies, unconstrained government power is frightening to capitalists. To do business, they must often purchase political protection or risk having their capital stripped by those with better connections. There are many incentives to support a movement toward political liberalization that will call predatory politicians and bureaucrats to account. In resource-rich societies, by contrast, this logic is less important. While individual capitalists may flee the grabbing hand of the state, oil, the source of wealth generation, remains safely trapped in the ground. Accessing this wealth does not require the complex institutions typical of most market democracies. The rule of law, for example, may give political outsiders avenues by which to challenge the ruling elite’s privileged access to oil profits (Easterly 2006: 125; Fish 2005: 137; Ross 2001). Yet, sharing this access may also prove an effective means of dividing opposition groups and buying societal acceptance of illiberal rule. Worse, foreign need for a strategic resource like oil will temper international criticism for domestic authoritarian behavior. In sum, where oil is present, the regime may face less pressure to democratize. The 2004 elections thus served as a turning point in Azerbaijani regime development. After a period of political liberalization that held out the prom-

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ise of genuine democratization, the leading kinship clans closed ranks with the ruling Aliyev family as security forces suppressed a strong opposition movement. In contrast to the other cases in this book, Azerbaijan took an authoritarian turn. Serbia and Georgia by contrast do not enjoy the dubious benefits of oil wealth. In both countries, however, the end of communism was dominated by illiberal political leaders who nontransparently manipulated privatization and control over state properties. Government opponents united with each other and mass movements to challenge this control in 2000 and 2003 respectively, when the government in power tried to steal an election. Unlike in Azerbaijan, however, many leading economic elites defected to support or, at least, to hedge their bets with the opposition. Georgia’s regionally based clan system appears to have accelerated the breakdown of central power. Without oil rents to cement loyalty, formerly strong supporters scrambled for the best deal from the new center of power. In Serbia, progovernment business forces similarly made deals and even financially supported the opposition. In the opening epigraph, Adam Smith warns of “the mean rapacity, the monopolizing spirit of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind” (1776). Smith had it right then, as he does now. If there is a lesson to be drawn from this book, it should be that where economic agents gain unobserved and unchecked control over the public sphere, they can wreak havoc on the public interest. In reading this book, I hope students of postcommunist politics will come to a further appreciation of the role that societies must play in policing the intersection of business and politics. The solution to the rapacity of the merchants and manufacturers is neither better businesspeople nor better politicians; it is a healthy and skeptical civil society with the rights and freedom to hold their political leaders accountable.

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2 The Command Economy and Its Legacies

There is no alternative. —LESZEK BALCEROWICZ, POLISH MINISTER OF FINANCE

All it takes is a tough government. —STANLEY FISHER

State Planning and the Hyperrational Principle

telling graffito appeared on the Berlin Wall as East Germans made their first forays into the West in November 1989: “They came, they saw, they did a little shopping.” After Berliners used their hard-won political freedom to buy VCRs and fresh fruit, many emphasized the obvious material failures of communism. Yet, the revolutions of 1989 also represented a bold victory for the liberal principle of individual choice. As Francis Fukuyama noted, the collapse of communism reflected the cognitive bankruptcy of the principle that a self-selected elite could make superior decisions on behalf of society (1989). Indeed, it was this fundamental hyperrational Bolshevik conceit that ensured communist systems would have to rely on repression (see also Scott 1998). According to historian Gale Stokes, hyperrationalism is the belief that one has superior scientific insight into the way societies work (1993: 5). For most of the twentieth century Marxist-Leninists invoked their self-proclaimed “scientific” superiority to justify politically expedient and frequently brutal policies. Individuals who resisted the Bolshevik elite’s

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decisions simply lacked the proper historical scientific insight to see things correctly. Their ignorance made them a political problem. At the very least, communist leaders ignored the choices and preferences of those who did not share their vision. At the very worst, there were persecution, imprisonment, exile, torture, execution, and a vast system of inhumane gulags. Joseph Stalin led the most brutal hyperrational regime of the twentieth century. Stalin sought significant acceleration in growth through a hyperrational program of industrialization fueled by forced collectivization of the countryside. The basic logic of collectivization was simple: extract savings from the peasantry to fund the capital expenditures necessary for a crash industrialization program. In practice, this meant organizing peasantry into vast collectives, expropriating much of their savings and material assets in the process. The Communist Party sought to skim off surplus labor to form a growing industrial workforce. More efficient farming—at least in theory—meant that agricultural savings could feed the new industrial workforce or be sold abroad to generate needed foreign currency earnings to buy essential industrial machinery, expertise, and technology. The state orchestrated its policies through central command carried out with military discipline. Even had the program produced balanced growth and helped eradicate hunger and disease, one could hardly have called a policy based on propaganda, rampant coercion, and brutality a success. Yet, the program failed in many of its own crucial indicators. Far from producing more efficiently, the huge collective farms proved incapable of matching the productivity of small, individually farmed plots (Kornai 1992: 76–83; Scott 1998: 193–221). Of less concern to the hyperrationalist Bolsheviks was the terrible human cost of Stalin’s policies. The Communist Party overcame peasant resistance to collectivization with measures that effectively murdered, starved, and terrorized millions of people (Conquest 1986; Kenez 1999: 98– 100). After World War II, it imposed only slightly moderated variants of these policies on Central Europe. Nevertheless, the command economy did eventually produce robust growth rates in certain sectors of the Soviet and Central European economies—particularly the heavy industrial and defense sectors so crucial to Soviet security policies. Indeed, the best estimates of Soviet growth reveal consistent overall growth in material output between 5 and 10 percent for almost three decades (Lavigne 1999: 58–59). Regardless of where one stands in the broader controversy about how to calculate growth in command economies, by the early 1970s, the Soviet and Central European economies had raised the living standards of most of their citizens.

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By the 1980s, however, these growth rates had plunged to low and even negative levels (Lavigne 1999: 58–59). What happened? The justifying conceit of central planners was that they could administer the resources of the economy more rationally than the collective individual decisions of consumers responding to changes in prices reflecting scarcity. Through administrative allocation of inputs and outputs the state could do away with the entire capital-owning class. Ideally, the state could then share the proceeds of the administered economy more equitably across a new classless society (Kornai 1992). By the 1980s, however, the joke ran that command economies made everyone both equal and equally poor. The joke rankled all the more as it became clear to all that far from becoming classless, an entrenched partyadministrative class (the nomenklatura) had perks and opportunities denied others. The main problem with central planning lay in the hyperrational nature of its command mechanisms. First, the execution of a central overarching economic plan required asking many, if not most, people to do things they would not do otherwise. Agricultural workers would become industrial workers, and the need to extract savings to industrialize would require that they work harder and with less reward than they would most likely accept voluntarily. Moreover, since safety, health, and environmental concerns rarely made it into the planners’ targets, many of the new industrial jobs were hazardous, difficult, and dirty. Why should people voluntarily subject themselves to this regime? Other things being equal, most would not. This created a glaring misalignment between the microincentives of the average person and the macroneeds of the state. The nomenklatura filled the gap through a combination of education and fear, backing one of the greatest propaganda enterprises in history with a beefy repressive apparatus. Ironically, the nomenklatura were the most likely to comply voluntarily, winning advancement and insider access to scarce goods (Kenez 1997: 217). The system operated on the hyperrational logic that the central planners’ choices were rational. But if that were true, individual choices that differed were, by definition, not. Indeed, all sorts of entrepreneurial actions that made perfect sense under market conditions—such as starting, expanding, or ending a business—were now irrational under the plan. Regardless of how logical such decisions were to the would-be entrepreneur, to the planners they looked like a spontaneous diversion of resources away from the command economy. Command economies were effective in mobilizing resources in society to produce rapid increases in growth in politically important sectors. It

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was a relatively minor matter, for example, for the state to use its coercive apparatus to transform poor peasants into steel workers and rich peasants into Siberian ore miners. Use coercion to move enough resources to one place, add the basic industrial technologies of the early twentieth century, and you would get growth. Command economies thus enjoyed significant periods of growth driven by this means of extensive mobilization of resources (Krugman 1994; Šik 1967). Yet what was to happen when most easily mobilized resources had been exploited? By the late 1980s, for example, 92 percent of eligible Soviet women were in the workforce—a typical level for a command economy, but far above Western mobilization rates. While Lenin’s commitment to emancipate women from “petty housekeeping” had the synergistic effect of allowing the economy to grow faster by producing more labor for the workforce, at some point there were no additional women available (du Plessix Gray 1989: 31). Unless each woman could produce more with the same inputs, limitations on their numbers would eventually constrain growth. Once the labor resource constraint was reached, command economies could only continue to grow through “intensive resource mobilization,” which is essentially shorthand for productivity growth (Kornai 1992: 180–186).1 Sociologist David Stark tells a good story illustrating the difficulties firms in command economies faced in achieving more productive use of resources.2 In Stark’s scenario, central planners in Moscow command a regional nail factory to support a growing building industry. The plan mobilizes all the resources necessary to make nails—the requisite metal, skilled and manual labor, electricity, transportation, and so on. It also determines where the nail factory’s product will go and what price the customers will pay. Finally, planners may direct the local branch of the monopoly bank to extend credit to the customers to pay for the requisite inputs. Let’s assume the nail manufacturer produces effectively the first year. Records indicate a burst of growth in net material product in the area of nails and a record number of buildings constructed with those nails. The plan appears to work so far. In the second year, however, the planners wish to continue the previous year’s growth, but they have allocated all available resources to the nail factory. They thus demand that the nail manufacturer produce more nails with the same inputs. It is up to the manager to accomplish this goal. Under pressure to meet the order to increase quantity, the nail factory manager simply skimps on quality. There are many ways to do this. For example, he may retool the machinery to produce more but shorter nails. He meets his target.

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When the construction enterprise takes delivery on the shorter nails, however, its carpenters find they cannot use them effectively. To compensate, they reduce the number of longer nails in their apartments. They meet their target, but their buildings are of lower quality. Real shortages of both quality nails and buildings immediately develop. There is no indication of either in the official statistics. The story continues. The director of the state-run construction enterprise might then explain to the central planners that there is a desperate need for longer nails. The planners then include length and quantity in their directive to the nail factory. The factory compensates by making more long nails but skimping on their width. making them brittle and equally useless to the carpenters. As the system develops, a number of things occur: 1. The plan gets increasingly complex, with huge information requirements challenging the central planning agency. 2. In the face of shortages, enterprises seek self-sufficiency, losing many of the benefits of specialization. Indeed, the construction enterprise might choose to go into the nail production business and, ironically, given the inability of the construction enterprise to build units to house nail factory workers, nail factory managers may decide to produce their own housing units (Lipton et al. 1990: 85). 3. Many things are not included in the plan, for example, adequate day care for employees’ children.3 These infrastructure items needed to be provided by the factory or its workers’ extended families. 4. Enterprises have an incentive to hoard resources—even those resources not directly linked to production needs. As a result, enterprises build large underutilized inventories, idle for the long term. This is a deadweight loss to the economy and one that is not reflected in growth figures. Enterprises hoard labor too. Stark observed that many state enterprises go idle a significant part of the year while the managers struggle to obtain the requisite material inputs. When the inputs do arrive, the factory kicks into high gear in an effort to fulfill their plan in a shortened period of time. This requires 24/7 production runs and two or three labor shifts. Factories thus had an incentive to staff a labor reserve. Ironically, this overloaded workforce produced little—at least officially—for a significant portion of the year, another important loss to the economy (Stark 1989: 648; Stark 1986; Lipton et al. 1990: 83). 5. Shortages become a significant factor in daily life. Fixed, arbitrarily set prices disallow higher returns for a scarce product. In a market economy,

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higher prices generally dampen demand and encourage supply. In the command economy, fixed prices suppress inflation, but customers feel it in the form of longer lines and waiting lists for scarce goods and services. Not surprisingly, illegal off-plan markets and exchanges quickly form, enabling those with connections, insider access, and knowledge to jump to the head of the line. Indeed, managers must often resort to such off-plan action to meet the plan’s targets. Within firms, this provides an opportunity for workers with important skills to exchange additional labor for perks beyond their wages (Stark 1989: 649). In yet another irony, entrepreneurial behavior—so irrational in the designs of planners—becomes crucial to easing the plan’s shortcomings. 6. The plan begins to shape social interaction and attitudes. Virtually everyone has a workplace from which they might be able to expropriate goods or services for private use. The workplace is thus turned into a positional resource that insiders access to exchange for goods and services from others. As often as not, people make these available to others without a quid pro quo. Stealing for others, with the understanding that they will someday steal for you, becomes a basic moral-cultural understanding of society. A common saying emerges: “if you don’t steal from your factory, you steal from your family.” Under this system, one’s wealth and opportunities come less from hard work—which is rarely rewarded—than from the positional resources available to one’s extended social network. What we call corruption is, in this system, morally expected and informally sanctioned. 7. Because credits are allocated according to plan, banks fail to discipline enterprises to operate efficiently. Hungarian economist János Kornai called this a “soft credit restraint.” Lacking any form of financial or market discipline, many firms effectively subtracted value from their inputs. In layperson’s terms, the world market value of the final good was frequently lower than the combined value of the labor, energy, and material resources that went into making that product. These were highly inefficient industrial economies (Kornai 1995). An important flaw of the command economies was therefore their inability to generate growth by making more with less. Communist economists realized this resource-constraint problem as early as the 1960s (Šik 1967), leading to a number of experiments in decentralization in economic decisionmaking, the Hungarian experiment in reform communism being the most notable. Communists soon found out, however, that giving greater autonomy to economic agents simply increased the parasitical relationship

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between the official and unofficial economies. In Hungarian reforms, for example, the more valuable skilled workers frequently won the right to use state factory equipment and labor to work off-hours in what were essentially private endeavors (Stark 1989: 187–189). They produced many needed items and helped the Hungarian economy reach higher standards of living than elsewhere, but they did so by draining resources from the official state economy. By the late 1980s, factory managers across the communist world took this logic to its extreme by using the right to set up private cooperatives to perform all sorts of services for state companies. Of course, the state company usually overpaid for these services, creating another drain on the official economy (Bartlett 1997: 122–124; Klebnikov 2000: 46–76). Indeed, decentralization essentially ensured that the state economy subsidized the private activities of those state officials with positional power to draw on state assets. Far from improving the efficiency of the state economy, decentralization and partial marketization accelerated its decline by allowing a diversion of state resources to private hands—which was exactly the reason Stalin had banned entrepreneurial activity in the first place (Nee and Lian 1994: 264; Lipton et al. 1990: 81). Another key experiment occurred during the Czechoslovak Prague Spring of 1968. Again, reformers envisioned decentralization of decisionmaking power in the economy and the introduction of partial market mechanisms. The unwillingness of Czechoslovak bureaucrats to release control over enterprises, however, led Ota Šik, minister of finance, to openly challenge the entire hyperrational principle of communism. Šik reasoned that the only way to get entrenched hard-line central planners to release their grip on the economy was to hold them publicly accountable for their actions: Czechoslovak economic reforms thus required a move toward political pluralism. Yet, this implied that average citizens could make better decisions through the democratic process than unelected communist bureaucrats could make in their planning agencies. Open political competition challenged the hyperrational justification for one-party rule. This proved unacceptable in Moscow. The Warsaw Pact invasion of August 22, 1968, put the hard-liners firmly back in control, while Soviet subsidies and credits raised living standards. Šik emigrated to Switzerland (Stokes 1993, 10–11; Šik 1967). As one can probably surmise from the preceding discussion, command economies were stymied by the challenge of making the transition from growth based on resource mobilization—extensive growth—to growth

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driven by better use of available resources—intensive growth (Kornai 1992: 181; Szelenyi 1989). Solutions threatened the essential hyperrational justification of the command system and provided new opportunities for those with positional resources to prey on the state economy. Decentralization in Hungary led to parasitical diversion of resources from public to private use and challenged the hyperrational principle that party planners could make optimal economic decisions for Hungarian citizens. Decentralization in Czechoslovakia politically challenged the hyperrational justifications for having powerful party elites in planning ministries. All solutions suggested that the decentralized, voluntary political and economic decisions of the people would produce a full changeover to resource-intensive growth and eliminate private appropriations of what were supposed to be public goods. In lieu of such a solution, communist Europe suffered a slow decline in rates of growth as governments ran into resource constraints and communist managers and bureaucrats preyed on the system (Lavigne 1999: 58–59; Nee and Lian 1994: 264–265). One should note, however, a significant exception in the 1970s where many command economies temporarily restored high growth rates. The main causes of the increase in Central Europe were twofold. First, newly tapped Siberian oil reserves infused energy resources into the system. It gave a lively bounce to growth in the Soviet Union and allowed the Soviets to buoy its eastern satellite states with subsidized energy exports (Kotkin 2001: 15–19). Second, a number of Soviet satellite states borrowed heavily from Western banks. These credits were in turn made possible by the relaxation of Soviet-US tensions during the détente period and by Western banks awash with Arab petrodollars following the fourfold increase of oil prices in 1973 (Poznanski 1996; Sprio 1999). These new resources bought command economies a decade or more of continued growth. Yet they failed to solve the basic productivity problems of command economies. Perhaps the best example was Poland. In the 1970s, Poland borrowed heavily from the West to finance higher consumer consumption and to import the latest Western machines to replace worn-out capital equipment. Some of these machines may have even improved productivity, yet the command economy ensured that any increases were limited to a onetime increase of growth: better machines produced more with less, but given the system, the productivity growth could not be sustained. Self-congratulations over a temporary increase in growth quickly gave way to concern over a significant and rising foreign debt problem. The government responded by raising prices and demanding that the Polish people save more and consume less to pay off the growing debt. These demands re-

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quired worker cooperation. In 1970, 1976, and, most notably, 1980, workers withheld their cooperation. Poland’s communists bought some time by recognizing the Solidarity movement in 1980, but by 1981 the union proved unable to discipline its workers and General Wojciech Jaruzelski suppressed the movement. When Poland’s elites once again ran afoul of budgetary problems in the late 1980s they turned to the Solidarity movement, which proceeded to negotiate a transfer of power in 1989 (Poznanski 1996; Stokes 1993). By 1989, Bolshevik hyperrationalism had run its logical course in Central Europe. Virtually no one continued to believe that a group of unelected technocrats could, or should, manage political and economic affairs on behalf of subject peoples. This disillusionment was particularly acute in the middle layers of the ruling communist parties of Central Europe. When opposition groups demanded that communists share or cede power in the summer and fall of 1989, the party apparatchiks were incapable of mounting a principled ideological defense. Bereft of workable legitimating ideas and denied the backing of Soviet tanks, mobilized societies simply removed them from power (Garten Ash 1990; Nee and Lian 1994: 259).

The Blueprint for Economic Reform

While the socialist systems probably could have struggled on indefinitely (Kotkin 2001: 1–5), Gorbachev’s choice of reform strategy (Cohen 2009: 136), profiteering communist elite, the revolutions of 1989, and the Soviet/Russian reforms of 1990–1992 brought an abrupt end to the European hyperrationalist experiment in central planning. Yet, prior legacies and efforts to circumvent the limits of resource-constrained growth left former European communists with a wide range of ending points. Communist Poland and Hungary were deeply in debt and having trouble simply meeting their international bills. Backed by Warsaw Pact occupation forces, hard-liners in Czechoslovakia raised prices to broadly reflect scarcity, helping the country to live more within its means—although certainly not entirely—until 1989. Experiences with economic decentralization also diverged. Hungarian and Polish enterprises had a great deal of autonomy while Czechoslovakia’s firms remained under tight state supervision. Similarly, an independent civil society had more fully formed in Hungary and Poland than in Czechoslovakia (Blanchard and Layard 1991; Lipton et al. 1990: 86).

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Given such macroeconomic, social, and administrative diversity, one would be hard-pressed to come up with a single set of prescriptions for market reform. Indeed, reformers faced a range of economic problems that varied in intensity or importance depending on each country’s specific legacy. Yet, these were often differences in degree, not kind. Indeed, the first generation of postcommunist economic policymakers faced a range of typical problems, and the mix and intensity varied from country to country. First, by 1989, nearly all command economies—even thrifty Czechoslovakia— were living beyond their means both internationally and domestically and thus suffered from at least a certain degree of macroeconomic instability. Unable to borrow more abroad or to produce products the world would wish to buy, most communist countries restricted their citizens’ access to foreign currency and markets. Unable to contain their fiscal expenditures or raise enough revenues to cover them, many governments simply printed money to fill the gap. Under market conditions, people would normally respond by spending their money quickly or trading it for a more stable foreign currency, but under conditions of fixed prices and currency inconvertibility, they were virtually forced to save. People had to endure long waits or enter illegal black markets to get what they wanted. However, high government spending helped finance access to decent, often sophisticated, health care; relatively good schools; guaranteed pensions; and jobs with state companies that would never go out of business or lay people off, no matter how inefficient. Critics felt that these high standards of living were unsustainable. Economies with such underproductive economies could not afford such luxuries. Dismissively, they called them “premature welfare economies” (Kornai 1995: 131). Second, command economies suffered from a range of problems in the area of trade. Trade illiberalism had a number of aspects. As noted, there were significant limitations on entrepreneurialism. The government usually set prices and tradesmen could rarely raise them, however scarce the goods they sold. Nor could private entrepreneurs legally go into competition with government-run enterprises. Imports were allowed into countries only after some process of political review. Generally, this review also ruled out any effective competition with state producers. Most countries made exceptions. Poland, for example, never succeeded in collectivizing agriculture and permitted market access to thriving smallscale farmers. Hungary experimented with mixed forms of public and private asset control. Yet, for the most part, government economic ministries retained vertical or horizontal monopolies over their economic sectors, leading to shoddy and otherwise uncompetitive goods.

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The third category of problems was structural. Command economies lacked organizational and institutional structures that made a market economy work. First, the state (usually through an administrative economic branch ministry) owned most large and medium—and frequently small— businesses. As we’ve already noted, the state was an indifferent owner and much more concerned with meeting the planners’ quantity output targets than improving the quality, cost, or marketability of the final product. The same state also controlled the commercial banks that did little to discipline poorly performing firms beyond providing new credits and rolling over bad loans, the soft-budget constraint (Kornai 1992: 140). Beyond this, there were very few of the institutional niceties that we associate with Western market structures. For example, there were generally no bankruptcy laws or commercial codes to ensure creditors were compensated or deadbeats punished. Underpinning the system was a legal code and a court system designed to ensure the continued monopoly of the Communist Party. The law—its interpretation and application—shifted easily to meet the current needs of the dominant cliques in power. The revolutions of 1989 brought to power a broad range of economists who sought to clean up this mess. They generally leaned in one of two directions. Neoliberal, or radical, economists compared their understanding of specific forms of capitalist market economies with the economic circumstances inherited from communism and plotted an economic policy trajectory between the two (Stark and Bruszt 1998: 81).4 They chose as their end point a highly individualistic, intensely competitive form of capitalism then in vogue with economists from the International Monetary Fund (IMF), the World Bank, and the US Treasury. Gradualists, by contrast, were more diverse, but frequently sought as their end point continental European forms of social capitalism with varying degrees of protection for societies against the atomizing forces of the unrestricted market. While economists diverged significantly over questions of speed, intensity, sequencing, and, indeed, end points, most agreed that macroeconomic instability, trade illiberalism, and structural imperfections needed transformation.5 Nevertheless, the following discussion—adopted loosely from Michael Mandelbaum (1993) and Jeffrey Sachs (1994)—essentially outlines the neoliberal reformers’ wish list. They sought to impose reforms on economies as quickly as possible. Gradualists would differ mostly in their choices of emphasis and sequence of individual reforms. They were also less enthusiastic about rolling back the capacity of the state to intervene in the market—preferring a strong state role—particularly in the restructuring of industries.

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Macroeconomic Stabilization

Macroeconomic stabilization restores stable values to assets within the country. The key stabilization measure is for the state to begin to live within its means, both domestically and internationally. This entails cutting state spending until fiscal deficits—shortfalls in government revenue—and current account deficits—cumulative country-wide spending on foreign goods and services—decrease or disappear altogether. Spending cuts affect almost every aspect of the economy. Enterprise subsidies, subsidized goods, and state services rarely escape without significant reductions. Price liberalization is often seen as an aspect of macroeconomic stabilization. By allowing prices to rise for scarce products, price liberalization ends shortages of many goods—with notable exceptions, people want fewer goods when they become more expensive. Allowing prices for basic items to increase also uses up the savings forced on the populace and eliminates the problem of too much money chasing too few goods. Rising prices can be self-perpetuating. As people get used to price increases, they tend to build them into their expectations and hedge against them in their wage contracts. This guarantees additional price rises. Inflation thus gets built into the economy. To prevent this, one area where neoliberal reformers actively sought state intervention in the economy was income policy to limit wage increases (Orenstein 2001: 13). Neoliberals argued that wages—and often pensions—not be allowed to rise as fast as inflation. As workers and pensioners have less real money to spend, they demand less, and retailers must restrain price increases to find buyers. Limiting increases in wages and pensions to some fraction of price increases thus reduces inflationary pressures. Monetary restraint also helps to combat inflation and thus stabilize relative asset values in the economy. States should make it harder to get money by raising lending rates, increasing the portion of savings that banks are required to keep in cash, and, perhaps later, exchanging people’s cash for a long-term IOU. As the amount of money available to consumers shrinks in relation to the goods and services available for purchase, money can command more and prices will stabilize. Monetary restraint is thus also an important brake on inflation. Some countries like Czechoslovakia adopted the additional constraint of currency convertibility—allowing people to freely exchange local currency for foreign currency. Should the government choose inflationary policies, people could then respond to the anticipated rise in prices by converting to more stable foreign currencies. The threat of capital flight would hopefully discipline the state. Conversely, once foreigners are con-

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vinced that the economy is stable, they can more easily buy local currency to take advantage of higher interest rates and low asset and labor prices. Trade Liberalization

Trade liberalization measures seek to unleash the suppressed competitive and entrepreneurial forces within society. Basic measures include opening the economy to foreign competition, thus forcing local producers to compete for their own markets. Breaking up supplier and retail monopolies also adds to the competition. Entrepreneurs should be allowed to start their own businesses, even when they threaten to take away the state’s business. Another aspect of liberalization is in labor markets. Although neoliberals called for wage indexing to fight inflation, they also sought to allow businesses to fire workers as needed. Greater trade and labor competition should also place an additional brake on inflation. Successfully undertaken, macroeconomic stabilization and trade liberalization policies seek to eliminate many of the distortions of a resource-constrained command economy. Most importantly, they end the administrative allocation of resources and replace it with price allocation that reflects resource scarcity. At the same time, the measures break up monopolies and unleash competition. After a brief rise in inflation, tight fiscal, monetary, and convertibility policies reassure domestic holders of capital that their assets will retain their value. This removes an incentive for capital flight even though citizens are allowed to convert their money to foreign currencies. Domestic and international capital holders now find the domestic economy a safe place to do business and to see their assets grow. Meanwhile, state-owned enterprises come under significant stress. They lose their subsidies and face competition from other enterprises within their newly demonopolized branches, as well as from foreign competitors. They also may find that it is now expensive and even impossible to obtain bank credits to meet supplier demands and payroll. Structural Change

The neoliberal economists fear that if the state remains the owner of an enterprise, the enterprise will not adjust to these changes. Rather, its managers will seek trade protection and financial bailouts, thus limiting competition and siphoning off crucial capital to money-losing enterprises. The end result is sluggish, distorted growth at best and stagnation at worst. For radicals, a dynamic economy is one in which such poor firms restructure or die,

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leaving their assets, such as land, capital, labor, and creative energy, to be picked up by new, dynamic firms. Reforms that promote structural change are designed to ensure that this creative destruction takes place. The most ambitious task of a postcommunist structural change program is the privatization of state-owned enterprises. Correctly implemented, a privatization program ensures an appropriate supply-side response—firms produce the supply, and consumers produce the demand— to new constraints and incentives placed on firms by a program of stabilization, liberalization, and related structural reforms. The hope is that private owners will seek profits and will eliminate wasteful practices. This includes cutting costs, which usually involves significant layoffs; introducing new technologies; finding additional markets; and eliminating the drain on enterprise resources through the private activities of managers and employees. To enhance the private owners’ response, reformers emphasize the need for additional structural reforms to ensure that the firms compete vigorously to survive. First, a strong bankruptcy law and the introduction of an enforceable framework for property rights ensure that nascent capitalists will feel secure investing their capital where it can bring the greatest rate of return and that creditors would be protected over debtors. Without these protections, enterprise managers do not have to honor contracts. They can go into debt with impunity, to other firms, to the government, and to the banks. Second, reformers should also restructure the banking sector. They should replace communist-era monopoly banks that had previously allocated credit according to a central plan, with a two-tiered banking structure. Below a newly independent central bank, they should establish commercial banks to grant loans to companies on the basis of market lending criteria, primarily adding significant incentives to enterprises to improve their bottom line. Privatizing these new commercial banks to profit-seeking owners will ideally further insulate them from political pressures to lend to failing enterprises. Privatization of the banking sector can thus help ensure that capital flows to winners and not losers. This, along with the discontinuation of state subsidies, confronts firms with a hard budget constraint and helps ensure greater freedom from political manipulation (Boycko, Shleifer, and Vishny 1995: 64; Kornai 1985: 12–15, 33–51). This is, of course, the neoliberals’ ideal blueprint. In reality, few governments adopted it wholesale and where provisions were adopted, there were frequently unexpected complications. We shall explore these complications and their politics in later chapters.

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Gradualists vs. Radical Neoliberals

The radical neoliberal reform blueprint promised to revolutionize social relations. Under communism governments buffered societies from the competition of the markets while societies developed extended social networks to assist their members with the shortcomings of the command economy. Markets would replace communist-era economic guarantees to society with hard social constraints. For a market to work efficiently, there had to be a price for failure to compete. Poor firms should go bankrupt, bad workers should (temporarily) go jobless, and obtaining resources at every level must become more a matter of hard work and merit than position and social connections. Above all, communism’s egalitarian society would be broadly split into new groups of winners and losers. The neoliberal caveat was that all this competition would lead to a more efficient use of resources and eventually raise collective well-being far above societies that coddled their members. Gradualists disagreed on several counts. The first complaint followed the well-worn lines of the wider battle between followers of Milton Friedman and followers of John Maynard Keynes. Echoing Keynes’s insights into the Great Depression, the gradualists argued that the full neoliberal blueprint would needlessly reduce the productive capacity of the economy (Nove 1995). Both sides agreed that the transition would be tough on societies, and economists on both sides stressed the need to build a comprehensive welfare net to catch those on the losing end of neoliberal policies (Lipton et al. 1990: 101; Marer 1993: 76–81; Sachs 1994: 47–48). As firms faced competition and came under a hard budget constraint, they would fire workers. As workers went home jobless, they would stop spending at local firms. Firms in turn would place fewer orders and fire more workers. Neoliberals argued, however, that the downward spiral was both selflimiting and partially illusory. Sachs, for example, pointed out the futility of low prices if goods were not available for purchase. Higher prices would eliminate lines and make goods available: expensive goods should be preferable to empty shops and worthless money. Moreover, economic activity would pick up. Local entrepreneurs and foreign investors would find ample new profit opportunities in low-cost, underutilized labor, capital, and material assets. International market integration would add the opportunity to produce for export markets. Self-sustaining growth based on efficient market allocation of resources would follow (Lipton et al. 1990: 119; Sachs 1994).

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Following Keynes, critics of neoliberalism countered that with an economy in shambles, there would be no one willing to invest to pick up the idled capital, labor, and equipment. Who wants to invest in a devastated economy with no customers? Rather than creative destruction, neoliberal policies would produce pointless economic devastation. As Joseph Stiglitz has argued in other contexts, workers would transition from low productivity to zero productivity (2002: 59). Governments should thus actively promote countercyclical policies with a particular emphasis on employment measures and new investment (Bresser-Pereria, Maravall, and Przeworski 1993). Rather than allowing the creative destruction of the market to run rampant, gradualists also sought to build on industrial building blocks already in place. Through careful, coordinated state-society deliberation via shifting “recombinant” networks, states could work with business leaders, banks, and labor to reallocate scarce capital and restructure firms along more competitive lines. The goal was to create broad participatory networks that would help avoid the untold social pain that bankruptcy, privatization, and liquidation would entail (McDermott 2002; Stark and Bruszt 1998). The gradualist vision promoted an alternative form or variety of capitalism from the highly individualistic, liberal, regulatory model advocated by the neoliberals. Gradualists were attracted to continental models of capitalism in which the state was more of a broker and coordinator of difficult transformational challenges than a disinterested regulator and adjudicator (Hall and Soskice 2001). Who was correct? In terms of economic policy prescriptions alone, it was very difficult to tell—largely because political realities led to hybrid policies and a variety of forms of capitalism. Hungary, for example, is often considered more gradualist because it failed to take neoliberal advice to impose drastic stabilization measures in 1990. By 1994 Hungary faced a significant macroeconomic crisis—requiring steep reduction in government expenditures—and an extended recession. Nevertheless, Hungarian policymakers succeeded early in disciplining all but a handful of state firms with significant competitive and financial pressures—hard budget contraints. Managers responded with significant efforts to restructure their businesses. As a result, the Hungarian economy was an early star performer (Bartlett 1997). Poland, by contrast, is often considered the model neoliberal reformer because of the radical macroeconomic stabilization program launched on January 1, 1990, by its minister of finance, Leszek Balcerowicz. Despite a significant downturn, the Polish economy surged forward—led by hundreds of small firms that flourished under stable macroeconomic and liberal trade

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conditions (Sachs 1994). Meanwhile, unlike “gradualist” Hungary, “neoliberal” Poland made virtually no progress in restructuring most of its large state-owned enterprises (Orenstein 2001). What is one to conclude from this small sample? Shafiqul Islam concludes that the initial debate between neoliberal and gradualist economists was relatively overblown (Islam 1993: 188; see also Orenstein 2001: 17). Countries had to work within the economic and political conditions they inherited and often lacked the freedom of policy choice assumed in the debate (Johnson 2001; Marer 1993; Stark 1992). As we shall see, it was perhaps not the exact policy mix that made the greatest difference. Rather, the key to strong economic reforms may have roots in their historical and politicalinstitutional context. A group that I call political liberals soon replaced gradualists as the neoliberals’ most outspoken opponents. The following chapter develops this argument in greater detail.

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3 Postcommunist Privatization and Politics

They are stealing absolutely everything, and it is impossible to stop them. But let them steal and take their property. They will then become owners and decent administrators of this property. —ANATOLY CHUBAIS

his chapter examines the political economy of postcommunist economic reform, with a particular focus on privatization. In the early 1990s, neoliberal economists sought to replace the hyperrationalism of command economies with their own hyperrational economic blueprint outlining the transition path to markets. Emphasizing that there is no alternative, neoliberals argued that the blueprint was the rational end product of economic thought (Orenstein 2001: 79). Publicly deliberating its details could only lead to irrational policy diversions. This predisposed the neoliberals to circumvent democracy rather than embrace it. By the end of the decade, political competition theorists had responded with a defense of democracy. Far from weakening reforms, they argued, democracy improves reforms’ effectiveness. It provides a mechanism to weed out failed policies. It also helps stop self-interested economic elites from capturing the policymaking process and using it for their own gain. Democracy, the political liberals argue, is the market reformers’ most important ally: open societies engage in vigorous deliberation and with access to more information can expose scams and failed policies. Political accountability gives people a means to eliminate what doesn’t work or is illegal.

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There has been little attempt to examine the role of postcommunist privatization within this debate. Yet, privatization programs create an important group of postcommunist capitalist agents. This genesis is bound, by its very nature, to be enormously controversial. It involves the imposing task of transferring the majority of a country’s wealth-producing assets into private hands and provides actors, to quote Croatian economist Nevenka ´ ckovi´c, “a one-off opportunity to get rich” (2002). Some will win access Cu´ to the process, and some will not. Postcommunist privatization is a highstakes competition among rival claimants to state-owned property. Privatization is therefore far too important to politicians to simply delegate to a set of well-meaning technocrats. Delegation in itself is a political choice that will benefit some at the expense of others. Politicians rarely leave the design of privatization frameworks to chance. I make two broad claims in this chapter. First, I argue that the nature of a country’s departure from communism influences the design, operation, and impact of postcommunist privatization programs. Where former communists control the transformation from communism, they are likely to design privatization frameworks that reward regime insiders. Where oppositions succeed in displacing the communists, by contrast, the design of the framework will reflect the relative political skills and power of the postcommunist left to prevail under politically competitive conditions. The second claim is perhaps more important. As the Chubais epigraph above states, some market reformers were relatively indifferent to who won the battle over privatization. After privatization, they expected owners both to restructure their firms to generate a profit and to seek to fatten that profit by demanding a better business environment. I argue, by contrast, that institutional context matters: if regime insiders can control the postcommunist transformation, they are also likely to use the same insider advantages to rig the business environment in favor of friends in the private sector. Far from promoting market democracy, illiberal, insider privatization can promote monopoly and corruption. Despite this, privatization does create economic agents with independent logics of action. In this chapter, I also explore these logics and the types of conditions under which they might spearhead a push toward a vitalized market economy. I will argue that postprivatization agents in illiberal countries are more likely to support political and economic liberalization where their profits are not tied to rents made possible by state policy and where a regime crisis has lowered the opportunity cost of disloyalty to the regime.

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This chapter begins with a review of the development of postcommunist thinking about the interaction between economics and politics. The second half will then hypothesize about the relationship between reform politics and privatization.

Neoliberal vs. Political Competition Theory Neoliberal Political Economy

Political freedom provided dissatisfied Central Europeans with the opportunity to protest, strike, and express disapproval at the polls. From the state worker’s perspective, there was a lot to find disappointing. A full slate of neoliberal reforms meant that one’s company would have to compete against rival firms. The state would also suspend subsidies to pay wages, and banks would only lend the enterprise money if it could turn a profit. These competitive constraints meant that the worker could be fired or asked to work harder and better than ever before. Nevertheless, a paycheck would carry less and less purchasing power as otherwise liberal market reformers kept wages low to fight inflation and attract foreign investors. Even so, new owners might still decide to fire a worker and when that happened, finding another job would be tough in the increasingly competitive economy. Many new jobs would require technical abilities, marketing and accounting skills, foreign languages, or familiarity with information technologies—none of which most workers had. Even if they had the energy to retrain for the new market economy, the relevant schools tended to be expensive and located in the main urban centers. Similarly, while employers might be hiring in other regions, housing shortages would make it doubly hard to relocate. For many state workers, the initial postcommunist period was one of unprecedented hardship.1 Neoliberals argued that this leant added weight to their case for a quick, neoliberal transition (Lipton et al. 1990: 87, 99).2 While hardly a neoliberal himself, Adam Przeworski gave this argument its most extensive treatment in his seminal book, Democracy and the Market (1991: 161, 168–167, 170).3 Przeworski argued that reformers had to get the shock of economic reform over with as quickly as possible. When the backlash set in, the economy would already be in recovery. By contrast, gradual implementation of reforms would be more likely to allow societies led by populist political entrepreneurs to organize, mobilize, and strike back by forcing reformers to either back down or step down from office. The risk of gradual reforms might

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thus be that economic reforms would never be sustained (1991: 178; Lipton et al. 1990: 87–88). Regardless, launching market reforms was expected to be politically difficult. Neoliberals looked for tactical advantages wherever they could find them. Polish neoliberal Leszek Balcerowicz argued that the fall of communism produced a brief period of “extraordinary politics” during which jubilant peoples would temporarily put aside their rational self-interest and accept hardships that would enable a broader transformation of the system. Postcommunist reformers, he later wrote, inherited a “nonrenewable resource, granted by history,” that they could use to implement painful economic reforms without generating significant social backlash (1995: 265).4 As an important member of Solidarity in the 1980s, Balcerowicz fought bravely for the political liberalization of Poland. Nevertheless, his emphasis on extraordinary politics reflected a broader neoliberal fear that democratic systems would not choose economic sacrifices during normal times. More broadly, neoliberal reformers saw little need for society to deliberate reform policy. Many economists compared themselves to doctors, who had professional access to the scientific knowledge necessary to cure a sick patient. This was vaguely similar to the hyperrational Bolsheviks of Lenin’s day. Both saw regrettable short-term means as necessary to achieve desirable long-term ends. Jeffrey Sachs even entitled the first chapter of his book on Polish reforms “What Is to Be Done Now?” thus deliberately paraphrasing Lenin’s hyperrationalist 1903 guide to building an elite vanguard party that would guide a country to the proletarian revolution (1994). To conflate Sachs with Bolshevism any further would be silly. Sachs is a strong supporter of pluralism and has fought on behalf of those hurt by market reforms—including repeatedly urging governments to adopt strong social safety nets to lessen the human toll of marketization. Yet, Sachs and others chose language reinforcing the impression that democratic deliberation could only detract from the program’s inherent economic rationality.5 The economic doctors feared that as democracies tried to pick and choose from the prescribed medicine, the economic patient would continue to sicken. Implicit in the neoliberals’ argument was the idea that the best solution was to isolate economic policymakers from democratic forces. This would include granting the executive powers to impose reform measures from the top down with only nominal legislative input.6 Democracy could and should flourish, but technocratic questions of economic reform should be left to the experts as much as possible (Crawford 1995; O’Donnell 1993: 338; Orenstein 2001; Schwartz 2006: 28; Szacki 1994). Read closely, the neoliberals expected a trade-off between markets and robust democracy. Political systems that successfully isolated the economic reform process

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under the wing of a strong executive were expected to have a significant transition advantage. One common practice was to give the nation’s president or prime minister special decree powers for a limited period of time to reform the economy as he and his trained economic advisors saw fit (Crawford 1995: 5). Neoliberals felt that such policies would strengthen democracy in the long run. Delay while politicians deliberated would only discredit markets and democracy. Were democracy to be shown ineffective in the short term, reformers feared societies would vote against political and market liberals in the next elections. Rapid market reforms, by contrast, would create a new class of entrepreneurs who would soon tire of the overbearing whims of bureaucrats and politicians and demand the institutions of the self-restraining state. In short, neoliberals hoped to play the role of sorcerer’s apprentice— unleashing political forces over which governments had decreasing control (Åslund 1995: 9; Shleifer and Treisman 2000). This recipe for success should work even under authoritarian conditions. Nobel Prize–winning economist Milton Friedman thus justified an advisory meeting with Chilean autocrat Gustav Pinochet on just such grounds. Market forces would ultimately drive democratization (Cran 2002). Others were more skeptical about the neoliberal claim that economic reform would drive political reform. Moreover, they feared the implications of hyperrational prescriptions for liberal ends implemented using illiberal means. Political scientists like Guillermo O’Donnell warned that superempowering executives in otherwise liberal political settings risked political degradation toward “delegative democracy,” an imbalanced executivedominated form of electoral democracy in which “people can vote, but they cannot choose” (1994: 94–110). Ideally, critics argued, reforms should build democracy and markets simultaneously. As Przeworski passionately advocated, “dual transitions require dual goals” (1991: 180–187; see also Berend 1995: 145; Haggard and Kaufman 1995; O’Donnell 1994). Regime Types

Postcommunist experience soon demonstrated just how important democracy was to postcommunist economic recovery. This is, therefore, a good place to define democracy and other regime types. Regime type will play an important role in this study, both as an independent and dependent variable. The rest of the book employs three regime types: liberal democracy, competitive authoritarianism, and authoritarianism. The term democracy has been used in so many ways that the term itself has lost utility. It needs an adjective and a clear definition. This book uses

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the term liberal democracy to describe a combination of “freedom, uncertain results and certain procedures” (Bunce 1999: 773) that makes it possible, as Przeworski so succinctly put it, that “parties lose elections” (1991: 10). This is a spare definition, but it implies a lot about the way a liberal political system is structured. Losing an election implies the right to run for office, choose between candidates, and the ability to inform oneself appropriately using freedom of speech, freedom of assembly, and access to alternative sources of ideas and information. It also implies stability in the rules of the game and with it the rule of law—ensuring that the winners of an election cannot subsequently exclude the losers from the playing field (Dahl 1989: 221). Ideally, liberal democracies protect and mold competition in three ways: (1) they allow societal accountability, that is, real constitutional freedoms enabling citizens to check their government and make demands upon officials; (2) they permit direct vertical accountability of officeholders to the electorate through regular free and fair elections; and (3) they ensure horizontal accountability of officeholders to other centers of authority in the form of robust checks and balances. Together, these institutional structures help to ensure that no individual or elite group can indefinitely stand above the rule of law (O’Donnell 2004). A major part of the following story, however, will involve regimes that have many of the formal trappings of liberal democracy, but which are not democratic in practice. There are many successful attempts to describe these gray-zone regimes (Carothers 2004), but here I employ Steven Levitsky and Lucan Way’s term competitive authoritarian regime to describe regimes that occupy the space between liberal democratic regimes and fully authoritarian regimes (2002). Competitive authoritarian regimes are imitation democracies that combine the formal political institutions of democracy with practices that constrain competition to give incumbents an insurmountable advantage (Shetsova 2007). Accountability of the executive to society, to voters, and to other political institutions remains an area of contestation. Some political space remains for opponents to challenge the executive, but if oppositions adhere to the formal and informal rules of the game, it is extraordinarily unlikely that they will take power (Levitsky and Way 2002). Competitive authoritarian regimes thus fall short of Przeworski’s minimalist threshold for a democratic regime, “a system in which parties lose elections” (1991: 10); results are close to certain, rules are malleable, and freedoms are constantly under threat. A regime slides into full authoritarianism when freedoms are missing or under assault, electoral contests are corrupted to the point where the results are guaranteed beforehand, and procedures can be changed at the

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whim of those in power (Bunce 1999; Deegan-Krause 2003). In these regimes, all three forms of accountability are virtually nonexistent. Civil society is regarded as a threat and suppressed; political institutions are fully subject to the power of the national or local executive; and elections are a mandatory exercise in demonstrating loyalty to the regime. Political Competition Theory

Positive arguments in favor of the reform efficacy of robust democratic institutions did not emerge until analysts like Joel Hellman began to present some good evidence that postcommunist Europe’s competitive authoritarian regimes were turning out to be poor reformers (1998). Some would argue that given their diverse historical, political, economic, and even chronological starting positions, comparing political performance between postcommunism’s best and worst political performers was unfair (Bunce 2003; Kopstein and Reilly 2000; Schwartz 2006: 7), but as our subsequent cases will help demonstrate, the relationship held even within states over time. Hellman argued that economic and political insiders could use a halfway postcommunist economic reform condition called a partial reform to enrich themselves at others’ expense. Abuse of communist-era reforms had already pointed the way toward the partial reform phenomenon (Nee and Lian 1994: 264). Managers of state-owned firms in many communist countries took advantage of reforms allowing them or close associates to establish their own private trading companies. The private company or coop then handled all the trade for the managers’ state-owned firm and, of course, overcharged or underpaid it whenever possible. The end result was a slow drain of state resources from the state to private accounts and a more rapid deterioration in the overall state of the economy (Nee and Lian 1994: 262–268; Kotkin 2001; Klebnikov 2000). This was classic partial reform. For the reform to be complete, the stateowned enterprise would then have to be privatized, at which point the new owners would then presumably stop the looting. As we shall see later, however, even this was often an insufficient additional reform. Partial reform had political ramifications. Hellman pointed out that rather than creating a constituency for additional change, the initial partial reform created a well-heeled constituency that would resist the sorts of additional reforms that would prevent them from scamming the economy. Where partial reform constituents succeeded at exercising a political veto over additional reform, the country would fall into partial reform equilibrium (1998: 204–205).

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Partial reform scams occurred everywhere in the postcommunist world, but they tended to be more enduring and more damaging in competitive authoritarian political systems than in liberal democratic ones. As Milada Vachudova later pointed out, they emerged wherever information about who was getting what was held asymmetrically. As scammers would seek to retain this asymmetry of information, they would also seek to limit liberal democratic reforms that might make this information both public and actionable (2005: 16–17). Partially liberalized economies and partially liberalized polities thus went hand in hand as mutually reinforcing phenomena. Indeed, in the postcommunist period, scams flourished and endured wherever democratic limitations, public policy, and economics intersected. Among other things, scammers could use political contacts—or simply corrupt a weak, incompetent state—to avoid paying taxes; win state contracts on uncompetitive terms; secure soft loans from politically controlled banks; and redirect subsidized materials for sale on world markets, then direct the difference to an offshore bank account. There were literally hundreds of such scams—many of which will be detailed in later chapters—attesting to both the highly creative, entrepreneurial initiative of postcommunist managers and politicians, and their willingness to maximize their advantages in a lawless, underregulated, and underobserved market (Kotkin 2001: 117; Barnes 2006: 12). That competitive authoritarian states would perform so poorly should not have come as a theoretical twist in the postcommunist story. As early as 1776, Adam Smith had warned us about the tendency of merchants and manufacturers to “conspire” to restrict markets and raise prices (1776: Book 1, chap. 10, par. 82). He didn’t focus on political context, but one can be reasonably sure that would-be monopolists prefer not to conspire in the open. Hellman’s groundbreaking work demonstrated how democratic freedoms thus can play an important role in the effective long-term functioning of markets— primarily by illuminating and breaking up antimarket conspiracies. Hellman’s article was an important milestone in what might best be described as political competition theory. Political competition theorists attribute the remarkable divergence in postcommunist trajectories to the presence or absence of political competition at the time of the fall of communism. Grzegorz Ekiert emphasizes that “legacies of dissent, opposition, and reform” are prerequisite conditions for early progress toward market democracies (1999). Valerie Bunce similarly finds that communist-era dissent must produce “a rough consensus about the political and economic successor regimes to state socialism” (1999: 761; see also Vachudova 2001, 2005). Such favorable conditions presage the observation by M. Steven Fish

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that regime opponents must be able to displace incumbents in the first postcommunist elections in order for economic reform to proceed (1998: 57; see also Ekiert 1999). The basic insight of political competition theory is that unless a postcommunist state gets its liberal politics right, its economics will be unlikely to fall into place (Hellman 1998; Hellman and Kaufman 2001; Manzetti 2003; Orenstein 2001; Puglisi 2003; Siegle, Weinstein, and Halperin 2004; Vachudova 2005).7 Postcommunist countries will embark on an illiberal political and economic pattern of change unless the elites of the old regime are forced from the scene at least once by a mobilized opposition that legitimizes its control through the electoral process. In the absence of a credible opposition that is willing and able to challenge for power, incumbents can control postcommunist change to preserve or even enhance their interests (Bunce 2003; Vachudova 2005). Scams were typical throughout the former communist world in the 1990s, but they flourished most in the countries of the Balkans and former Soviet Union where the first postcommunist oppositions had failed to contest the old regime for power. Lacking transparency and an effective challenge from the opposition, incumbent victories in founding elections helped ensure that scams would proliferate and endure. As we shall see, their impact diminished as the quality of democracy rose. Mitchell Orenstein adds additional insight into why Europe’s more robust postcommunist democracies appeared to be doing better with economic reforms. Even the best economic reformers, he argued, will make policy mistakes (2001). Unless ruling parties are frequently changed, however, these mistakes are likely to continue for three main reasons. 1. Following Hellman (1998), Orenstein points out that policy mistakes breed significant beneficiaries. These beneficiaries become stakeholders in resisting a solution. Their resistance is more likely to succeed where they have little political competition. 2. Incumbents tend to discount the critiques of their opponents and thus often ignore good advice. 3. Changing policy may not only be seen as an embarrassing admission of failure, but may also challenge fundamental ideological predispositions that rulers hold dear. States are thus least likely to fix policy mistakes in less competitive systems where governments can prolong their hold on power. Failed policies in competitive democratic systems, by contrast, commonly contribute to a

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change in government. Regardless of the reason, frequent government turnovers provide democratic rulers more frequent opportunities to learn from their predecessors’ mistakes. Orenstein’s conclusion was that far from slowing reforms, defeating even neoliberal reformers at the polls might help spur faster reform and better policies through policy corrections (2001: 137– 138). Anna Grzymala-Busse also develops the concept of competition by demonstrating how robust party competition produces policy moderation. Among other things, parties in power may police their self-dealing for fear of criticism by oppositions and punishment at the polls. They may also coopt their critics in an effort to dilute the opposition’s message. Finally, incumbent parties may also seek to limit officials’ discretionary power over state controls in the clear understanding that unless they do so, their opponents will use it to their advantage once they gain power (2007: 17). The implication of political competition theory for neoliberal political economy is relatively straightforward. As Orenstein points out, economic technocrats are fallible. Hence, isolating economic policymakers from the democratic process may simply lock in failed policies and reinforce it by creating stakeholders who benefit (2001). Even liberal democracies can suffer from a lack of political alternation. As we shall see, in the Czech case, the Communist Party developed few portable skills after 1968—skills such as experience with managing reforms, negotiating with opponents, ideological pragmatism, or technical expertise. It thus lacked the political agility to reshape the party program in ways that would appeal to postcommunist electorates. Having not been challenged since 1968, the Czech Communist Party lacked both the mentality and organizational ability to transform itself. While it polled strongly in the 1992 election, it remained unrepentantly Bolshevik and essentially irrelevant to coalition politics (Grzymala-Busse 2002a, 2002b). This allowed the Czech right to dominate politics for longer than in other countries. Political competition theory also taps into a broader theme of political economy dating back to Karl Polyani (2001). Societies, where permitted, will, and probably should, resist the imposition of significantly socially disruptive reforms (Scott 1998). For this reason, John Grey has argued that democracy is in the long term incompatible with the neoliberal “utopian project” to subject unwilling societies to unfettered market forces (1998: 1– 22). Political competition theorists would see this as a good thing. We don’t want politicians designing great schemes for our benefit without our input. Political competition limits the most grievous social damages that hyperrational social engineers can inflict.

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To reiterate an earlier point, despite its emphasis on individual economic freedom, neoliberal political strategies thus have something of a “high modern” flavor: a reform blueprint drafted on behalf of citizens, without their input, ready for adaptation and imposition by authoritarians or temporarily empowered executives (Scott 1998: 220–222; Stark and Bruszt 1998).8 Despite all the hard work economists have put in on behalf of postcommunist peoples, ultimately democratic polities should be the final arbiter of most economic reform policies. Brief Reality Check

The debate between the neoliberals and the political competition theorists is by no means settled, however. Neoliberals may have overestimated the capacity and integrity of strong executives to adopt reforms, and they underestimated the importance of robust societal checks in reducing the self-dealing in economic reforms, but they were at least realistic about the short-term prospects of liberal democracy and opposition politics in much of postcommunist Europe.9 Indeed, given the dismal political conditions of the former Soviet Union in the early 1990s—lands largely bereft of civil society, developed party systems, and committed democrats—the only real arena in which to make immediate progress was in the economic sphere (Åslund 1995: 11; Bunce 2003; Shleifer and Treisman 2000: 34). Worse, there seems to be little room for political and economic agency in political competition theory. Illiberal patterns of postcommunist change produce partial reform equilibria. Economic actors behave accordingly. The approach is very structure-dominant. With all the arrows pointing in an illiberal direction, escape to liberalism must thus arrive deus ex machina.10 Yet some illiberal postcommunist countries—from Slovakia to Serbia—have liberalized. One mechanism is external pressure. Vachudova, most notably, has masterfully demonstrated how the “active and passive leverage” of the European Union (EU) provided oppositions with the resources through which they could better hold their governments accountable and provide contests for power (2005; see also Jacoby 2004). Yet, EU leverage might to an extent be a sui generis phenomenon; it can help explain Slovakia, but offers less hope to Ukraine, where much of the population expresses little desire to become European. With the exception of the Balkans, EU leverage may have reached its potential. NATO’s membership conditions suffer even greater geographical and credibility limits. In addition, other attempts at achieving political liberalization through external leverage have not performed nearly as well. In the cases of the In-

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ternational Monetary Fund (IMF), World Bank, and other international financial institutions, charter restrictions on political interference prevent explicit institutional demands on elites to change their regime type. Similarly, efforts at improving governance as a means to improve economic policy have often failed—usually in the face of self-interested incumbent elite rentseeking. At best, IMF conditions may make resisting reform so painful that elites choose to comply, but even then, the reforms are likely to serve as window dressing for new patronage schemes (Easterly 2001: 18; O’Dwyer 2006). How then are illiberal postcommunist regimes to liberalize? If we accept the political competition theorists’ critique of neoliberal political economy, neither approach solves the problems of building liberal democratic political institutions from within illiberal societies. Fortunately, as we shall see, the news is not all bad for political liberals. Empirically, competitive authoritarian regimes have proven quite unstable, and economic agents have played a role in that instability. The electoral upsets of ex-communist elites in Serbia in 2000, Georgia in 2003, Ukraine in 2004–2005, and, arguably, Croatia in 2000 displaced competitive authoritarian regimes, at least temporarily, while the 1998 elections in Slovakia displaced a government that was in the process of pushing democratic institutions to their breaking point. In all five countries, popular mobilization against authoritarian rules of the political and economic game created a crisis for the regime. With the partial exceptions of Slovakia and Croatia, incumbent rulers sought to relegitimize their rule through fixed or heavily tilted elections. In every case, a unified and highly mobilized opposition refused to abide by the regimes’ heavily biased or rigged rules. The result was a regime crisis. Levitsky and Way argue that competitive authoritarian regimes are likely to be prone to such crises. Specifically, the combination of open space for political competition with the authoritarian mechanisms and instincts of the incumbent regime can be hard to maintain over time. Given adequate space, regime opponents may succeed in putting enough competitive strain on the regime to render political outcomes less certain. When this occurs, incumbents face a competitive authoritarian dilemma. On the one hand, they can attempt to preserve their control over outcomes through repression. On the other hand, they can risk losing control through regime liberalization (2002: 53–54). Whichever choice they make, some form of regime transformation is likely to follow. In Chapters 7 and 8 of this book, we will examine the important but poorly appreciated economic component of the competitive authoritarian dilemma. Through an examination of Ukraine, Serbia, Georgia, and Azer-

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baijan, we will see that under certain conditions, the neoliberals were right: market reforms and especially privatization may produce economic agents seeking more liberal politics and less government intervention in the economy. I examine these logics in the next section.

The Political Economy of Privatization

The previous section reviewed ways in which political economists have thought about the interaction between postcommunist economic and political change. This section examines the role of privatization within that debate. Neoliberals, not surprisingly, maintain a number of strong and often unchallenged hypotheses about privatization’s role in building a market democracy. The primary task of this book is to provide a response grounded in political competition theory that is free of structural determinism. The Neoliberal Model

In the rush to provide postcommunist reform-oriented politicians with practical and useful privatization advice, neoliberal economists emphasized a model developed by Ronald Coase (1960; see also Boycko, Shleifer, and Vishny 1995). Coase's model assumes a society of rational profit-maximizing agents with the ability to write and enforce contracts. Should an agent realize that his neighbor’s behavior is costing him money, the agent may find it profitable to sign a contract agreeing to pay the neighbor to stop the damaging behavior. Other things being equal, if a farmer is losing $1,000 per year due to the pollution of a neighboring factory, he should be willing to pay up to $999 per year to clean up the factory's pollution. Even if the farmer pays $999 to have the factory reduce its output, he will still be $1 per year better off than he was before. Contracting will have added a net material benefit to society. Before Coasian contracting can take place, however, the first distribution of rights must take place. It might seem unfair to some readers, for example, that the factory owner has a right to pollute the air, forcing the farmer to bear the expense of reducing pollution. A different political process might produce a system in which the factory must compensate the farmer for his loss. The question of “who compensates?” is irrelevant from the neoliberal Coasian perspective. Indeed, if the property rights framework forces the factory owner to reimburse the farmer for the $1,000 per year of damage he’s causing, the factory owner will pay up to $999 per year to eliminate his

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own pollution. This will allow him to save $1 or more per year over the cost of compensating the farmer. Regardless of the initial distribution of rights, however, the economy will register the same $1 increase in income (if the fix costs more than $1,000, he’ll just compensate the farmer the full amount). Neoliberals are thus indifferent to the processes that determine the preliminary distribution of rights. This allowed neoliberals to be remarkably sanguine about the politicalinstitutional context of privatization. Old communist managers and functionaries might capture political institutions and use them to privatize to themselves. They might even steal state property, and, as Russian privatization chief Anatoly Chubais notes in the opening epigram, it makes little or no difference to the neoliberal perspective.11 The end result of privatization is a private owner who is free to make contracts increasing efficiency and profits. Delay only ensures that enterprises continue to stagnate in state hands. Yet there are a few details buried in Coasian analysis that in hindsight should have given neoliberal practitioners greater pause. In particular, neoliberals assume a rigorous legal framework to protect property rights and keep contracting costs low and enforceable. Where this is ensured, Coasian contracting can take place autonomously. But this raises a significant chicken-egg problem in the postcomunist context. Should privatization occur even where property rights and the rule of law are weak? In the early 1990s, the neoliberals said yes, the priority is to depoliticize firms—to get them out of state hands as quickly as possible. Rule of law and corporate governance issues would have to wait until later (Boycko, Shleifer, and Vishny 1995: 24–25). Given the wholesale predation and mismanagement of state-owned firms occurring at the time, this was entirely understandable (for good examples of the mechanics of predation circa 1990–1991 in the Soviet Union, see Klebnikov 2000). The neoliberal hope was that after privatization, new owners would see the value of establishing a better private property rights framework and the rule of law. Corruption and bureaucratic barriers, for example, would add to the cost of contracting. To return to our first illustration, if the farmer has to pay a $100 bribe to a government official to install $999 worth of pollution abatement equipment on the factory, the total cost of the transaction will rise to $1,099, or $99 more than the savings the equipment will achieve. Faced with this prospect, the farmer must continue to accept the $1,000 loss. He will also resent the corruption and self-dealing state officials who cost him money. Neoliberals like to point out that prior to privatization, there was no one to resent the state’s grabbing hand. Privatization thus creates a coalition of potential political victims: property holders who want a political institu-

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tional framework that will lower the cost of contracting to the minimum and protect their property. Privatization potentially creates agents of liberal political change (Boycko, Shleifer, and Vishny 1995: 154; Schwartz 2006: 30; Shleifer and Treisman 2000: 37; Shleifer and Vishny 1998: 10–11). Coase provides a compelling case for rapid and thorough postcommunist privatization policies under all sorts of political-institutional contexts. The following argument develops a response to the neoliberal approach, based in political competition theory. I make two claims: (1) the design and operation of a country’s privatization program will reflect its postcommunist inheritance; (2) this inheritance shapes the subsequent political and economic impact of the privatization program. There are plenty of examples where postprivatization winners act exactly as neoliberals predict. However, as Andrew Schwartz explains, postprivatization winners often follow distinctly non-Coasian logic (2006: 76–79; Barnes 2006). The neoliberal model’s applicability has thus proved to have a more narrow scope than originally hoped. Table 3.1 outlines the first part of the argument. The design and operation of a privatization framework will reflect the country’s broader postcommunist transformation pattern and the portable skills of the postcommunist left. Where former communists control the transition away from communism they are also likely to control the design and operation of property transformation programs. Where they are instead displaced by a democratic opposition, the privatization framework is likely to reflect the democratic political skills of the postcommunist left to shape its design. I employ the term privatization framework to capture the distributive aspect of the battle over state-owned property. The term assumes that any privatization program privileges some groups of people over others. While there are many possible classification schemes for a privatization program, this chapter examines how privatization frameworks vary between insiderand outsider-dominated.

Table 3.1 Factors Shaping Choice of Privatization Framework Postcommunist Pattern The Left’s Portable Skills

Liberal

Illiberal

Low

Outsider privatization: Czechoslovakia, Czech Republic

No cases expected

High

Insider privatization: Slovakia

Insider privatization: Ukraine

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Insiders and outsiders are potentially rival combatants over who gets state property and under what conditions. Insiders benefited from their proximity to state-controlled property under communism—their positional resources. Generally, they now wish to make proximate state property their own, or, at least, to prevent others from getting it. Insiders can include former communist ministry bureaucrats, high-ranking party members, economic or political allies of the executive, state enterprise managers and their associates, and state enterprise employees. Outsiders also want state property, but will have to remove insiders from their positional control over the assets if they are to get it. Outsiders include average citizens, foreign and domestic investors, private-sector entrepreneurs, and the government’s political opponents.12 An insider-dominated framework empowers a select group of insiders to exclude rival claimants—often other insiders—from the privatization process. An outsider-dominated framework, by contrast, provides outsiders with access to the privatization program. It may compel insiders to compete with them on an equal playing field or exclude insiders altogether. The concept of a privatization framework captures the initial, near-zero-sum distributive nature of designing and implementing a property transformation program. Variation in the privatization framework reflects a country’s postcommunist political transformation pattern. As a proxy for the postcommunist pattern, this chapter uses political regime type. As noted, illiberal patterns start with the inability of societies to fully dislodge incumbent elites from power at the moment of transformation from communism. The lack of a strong political challenge allows elites to manage the transformation by creating imitations of democracy that mask competitive authoritarian or authoritarian regimes. The result is that communist-era stakeholders can control or distort the introduction of economic reform policy. In the realm of privatization, one expects the privileged political actors who are controlling the transformation to also shape who claims the major assets of the state (Bunce 1999: 783–784). Venelin Ganev perhaps puts it best: where communist incumbents retain control in the founding elections, the subsequent process separating resources from the state becomes an intraparty affair in which no party stands to defend the interests of the state. The incumbents simply use the “marketization” and “democratization” processes to take what they want (2007: 17). Liberal postcommunist transformation patterns occur, by contrast, where active oppositions and free and fair founding elections sweep aside communist incumbents. But this does not necessarily imply that more lib-

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eral postcommunist democracies will always produce outsider-dominated privatization frameworks, or that outsider-dominated frameworks will work better where they do prevail. As Ganev asserts, where the incumbent communists lose a founding election and go into the opposition, the process of separating resources from the state becomes a competitive interparty process subject to social and political scrutiny, punishable at the polls and hence more moderated (2007: 17). Under these liberal democratic conditions, the distributive implications of the privatization framework depend on the portable skills of the postcommunist left. The left—most notably trade unions and ex-communists—will do better in competitive politics where it has an established legacy of fighting for the destruction or reform of communism, or where it has developed good political skills and pragmatism through negotiating with the opposition and attempting to reform the command economy. They will do poorly, by contrast, where they lack these portable skills, rigidly adhere to received orthodoxies, or are associated with the oppression of the previous regime (Bunce 1999; Grzymala-Busse 2002a). This is borne out by the success of labor in Poland and Slovenia—both liberal postcommunist pattern cases—in shaping property transformation regimes. Despite the introduction of strict neoliberal reforms by Poland’s first postcommunist minister of finance, Solidarity’s labor wing emerged from the transition powerful enough to retain a veto over privatization choices. As a result, large, industrial privatization moved slowly, or, more frequently, didn’t occur at all. In 1994–1995, however, a left-oriented government secured worker participation in a medium-sized, equal-access, voucher privatization program—an insider framework. Throughout, Polish industrial privatization rewarded outsiders only on an ad hoc basis (Orenstein 2001). Similarly in Slovenia, left forces guided the break with communism via the independence movement. Prior to the fracturing of Yugoslavia, Slovenia’s communists had maneuvered for greater autonomy within the federation and gained at least some democratic legitimacy as a defender of Slovenian national interests within the Federal Republic of Yugoslavia. While the communists lost the first democratic elections, former Communist Party leader Milan Ku´can won a presidential runoff election with a strong 60 percent of the vote (Stokes 1993: 241–242). The democratic success of the postcommunist left helped ensure ongoing protection for Yugoslavia’s traditionally socially owned enterprises, in which management of firms was determined through each firm’s internal decisionmaking procedures. As in Poland, this initially resulted in a slower, insider-restrained privatization framework.13

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There is nothing wrong per se with an insider-dominated privatization framework—especially under liberal political conditions (Frydman, Murphy, and Rapaczy´nski 1998). Economists expect that economic agents, whether insiders or outsiders, will respond relatively consistently to economic incentives—get the incentives right and private owners should restructure their firms and engage in efficiency-enhancing contracting (Boycko, Shleifer, and Vishny 1995: 10).14 This study finds nothing to contradict this. In postcommunist Europe, however, insider privatization frameworks are frequently associated with illiberal postcommunist transformation patterns, distorted incentives, and an effort to preserve the interests of excommunists. Positioned with asymmetric access to both wealth and power, insiders are likely to fight to retain this asymmetric access. As Table 3.1 shows, the four countries that are the primary focus of this study demonstrate this relationship. Ukraine provides the prototypical example of an illiberal transition, managed by ex-communist insiders to preserve their interests. Privatization there, as we shall see, worked to enrich diverse groups of political and economic insider elites to retain their asymmetric access to wealth and power. In Czechoslovakia, by contrast, the Velvet Revolution set the stage for a relatively robust and democratic political competition for power. (The Velvet Revolution is the name observers have given the popular protest from November 17 to December 10, 1989, that brought an end to Czechoslovakia’s communist regime; for a popular description, see Garten Ash 1990.) Incumbent communist elites did particularly poorly in this competition. Communist-era management and union interests had little impact on the design of the country’s initial privatization framework and participated in privatization on the political right’s terms— a condition that remained more or less unchanged in the Czech Republic after the Czech and Slovak republics separated on January 1, 1993. Slovakia is an in-between case. As in the Czech Republic, insiders were discredited by their support for the hard-line communist regime after 1968. But after being initially displaced by the Velvet Revolution in 1989, the excommunist left regained at least some political influence by closely aligning with the concerns of nationalists over the distribution of power in the federal constitution, federal control over economic reforms, and other issues. Following the Czech and Slovak “divorce” on January 1, 1993, insiders fought to sideline the Czechoslovak privatization framework that excluded them and to replace it with a Slovak framework that they could control. Unfortunately, to succeed, this process of reorientation required attacks on democratic institutions that could prevent it. The insiders’ bid for exclusive access to state property thus further energized a nearly successful attack on democratic institutions.

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The Slovak case reveals greater complexity than captured in Table 3.1. By the end of Me¸ciar’s third government in 1998, Slovakia was arguably on the verge of becoming a competitive authoritarian state. The case raises the possibility that the relationship between privatization and political context is recursive, that is, it moves in both directions. In countries with weak and embattled liberal political institutions, privatization can catalyze their further contestation. We are most likely to observe such contestation in weakly liberal or competitive authoritarian states. As opposed to authoritarian regimes, ruling elites in competitive authoritarian regimes do not have complete control over political life. Enough freedom to maneuver exists to permit significant public debate over distributional battles like privatization. The political sphere is more fluid than in authoritarian or liberal democratic regimes, and the rules of the political game are more uncertain. For example, outsiders can use a competitive authoritarian regime’s limited political space to seek crucial information about the privatization policymaking process. To enlarge and protect this space, they may seek to strengthen democratic institutions and build a more informed and politically active society. Insiders will find this access threatening, by contrast, and seek to limit it. Hence, in a contested democracy, a battle over privatization framework can easily intensify the fight over privatization’s surrounding political institutional framework; it might even contribute to a competitive authoritarian regime crisis (Bunce 1999; Levitsky and Way 2002). Given strong opposition, however, a competitive authoritarian government may be tempted to bolster its legitimacy for insider privatization through mass-access privatization programs, but then seek to ensure that mass participation is so limited in scope that it does not give away any real control of lucrative enterprises. Indeed, this was basically the fate of voucher privatization programs in Croatia, Russia, and, as we shall see, Ukraine (Appel 2004; Gould 2003; Gould and Sickner 2008). Rulers may also use nationalism to justify why regime insiders are getting the lion’s share of state property. As we shall see here, identity arguments will be an important part of the politician’s arsenal—especially when explaining why some people are eligible for privatization benefits, while others are not. Privatization thus interacts with broader discussions about national identity (Appel and Gould 2000; Vachudova and Snyder 1997). Earlier empirical work by this author bears most of these hypotheses out (Gould 2003). In a survey of the dominant privatization frameworks as of 1997, authoritarian countries chose exclusively insider-dominated frameworks as their primary mode of privatization; grey-zone countries chose mostly insider-dominated frameworks, but a few also offered popular mass

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privatization frameworks—most of which insiders either manipulated or limited in scope to ensure control; the most liberal democracies selected frameworks that, more or less, reflected the relative power of the postcommunist left. That a political legacy would strongly shape the design of privatization frameworks was both known and expected by neoliberals. Indeed, neoliberals were partly responsible for the phenomenon. In Russia, an illiberal-pattern case, market reformers could not even imagine a privatization strategy that was both “preferred from the efficiency viewpoint” and “politically feasible” (Boycko, Shleifer, and Vishny 1995: 65–66). The best strategy was therefore to “consistently and generously” recognize stakeholders’ claims and thereby ensure their support for privatization (Boycko, Shleifer, and Vishney 1995: 13). Neoliberals thus accepted the questionable character of many property owners, and some neoliberal policymakers, as we shall see in the Czech case, even appeared to accept unethical means of acquisition. They reasoned that institutional changes ensuring more efficient contracting, the rule of law, and state restraint would come later—supported by now-independent private economic agents. In short, an illiberal country with private property had a brighter future than one without. Yet, can postprivatization agents be relied upon to fight for liberal economic and political change? Here the neoliberal arguments of the early 1990s get murky. For neoliberals, insecure property rights and the high cost of enforcing contracts present a threat to Coasian contracting. If ownership is unenforceable or unprotected, those closest to the cash will seek to cash out before someone else beats them to it. Privatization in the absence of the rule of law is thus more likely to produce asset stripping than market-oriented entrepreneurial behavior (Shleifer 1997). In addition, the tendency to seek private protection in lawless environments greatly increases the transaction costs as various private agents typically provide their services at higher prices than the state (Denisova et al. 2008). To work more efficiently, therefore, Coasian contracting requires the basic economic institutions of what classical political economist David Hume considers a “just state.” This is a state that upholds property rights, protects the right to transfer property voluntarily, and compels agents to uphold their lawful contracts (1739: Book III, secs. 3–7). Unfortunately, privatization programs across postcommunist Europe—including the liberal-pattern cases—occurred before the institutions of the just state could be fully realized.15 In postcommunist Europe, however, more democratic societies were faster at developing these institutions than less democratic societies. More

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democratic societies arguably had a head start, but the ability of democratic societies to inform themselves and protect against postprivatization predation was also greater (Hellman 1998).16 Private agents face weaker incentives to build the just state in less democratic societies. Critics of rapid privatization Karla Hoff and Joseph Stiglitz developed a formal model demonstrating how privatization in the absence of the rule of law is unlikely to create demand for political liberalization. Once owners have engaged in asset stripping, they are afraid to demand rules that will constrain or punish them in the future.17 Worse, even if an executive wishes to provide amnesty to those responsible for questionable means of property acquisition, today’s executives have problems making credible future commitments to protect property in the uncertain world of political futures. The inability of the executive to make a credible, longterm property rights enforcement commitment encourages owners to cash out by stripping value from their firms. The authors conclude that privatization before the rule of law is secured “may put into play forces that delay the establishment of the rule of law” (2004). Similarly, Konstantin Sonin shows how large-scale privatization winners in illiberal environments protect themselves against expropriation by investing in “private property protection systems.” These often take the form of close ties to political officials that pave the way for lucrative rent-winning opportunities. Given the profitability of such cozy relations, illiberal privatization contributes to a postprivatization equilibrium in which the rich and powerful resist reforms promoting accountability and the rule of law (2003; see also Frye 2002; Glaeser, Scheinkman, and Shleifer 2003; Hellman 1998). In short, creating agents before institutions—while perhaps the only politically feasible choice at the time—had significant long-term complications. By advocating rapid privatization by any available political means, neoliberals helped ensure that property owners emerged prior to an adequate legal framework to induce efficient corporate behavior or to prevent public-private collusion. Rather than fight for liberal reform, postprivatization winners often used their influence to keep the institutional framework weak. To their credit, it did not take long before the economists noticed the problem. In the late 1990s, mainstream economists stressed the need for concurrent market institution building to ensure low-cost, enforceable contracting, particularly in the area of corporate governance, and strong financial constraints on privatized firms (IMF 2003; World Bank 2002b).18 In the chicken-egg debate over which should come first, institutions or economic agents, institutions had won.

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Toward a Theory of Postprivatization Agency

The belated victory for the importance of institutions did little to solve the problem of how to build state accountability, bureaucratic restraint, and the rule of law in illiberal countries where many of the main postprivatization actors and politicians were threatened by liberal change. Hope developed, however, as some postcommunist societies began to address these problems themselves. From the Balkans to Central Asia, oppositions to competitive authoritarian regimes sought to use the constrained political space to hold incumbent governments accountable for their self-dealing and to press for liberal regime change. Many of these movements found support among parts of the newly established business sector—just as neoliberals would expect. But just as importantly, large portions of the business sector did not join in. Political competition theorists and neoliberal Coasians should thus both be able to agree on the need for research projects that investigate the contingency of postprivatization agents’ political behavior. At this point in history, most observers of postcommunist politics would probably agree that Coasian logics of economic and political behavior have intermingled with non-Coasian logics (Schwartz 2006). But how and under what circumstances? We need a theory attempting to untangle these logics. There has been some work done on this. The neoliberal explanation is that postprivatization agents will demand reform and the basic institutions of the self-restraining state when it is good for the bottom line. This is consistent with Coasian logic. First, patronage obligations are likely to carry both political and economic costs. Failure to deliver political goods may lead to various forms of expropriation or worse. Second, the local legal and economic environment may drive important clients and suppliers elsewhere. Third, the insider appropriation of the state’s intersections with economic activity will likely worsen macroeconomic fundamentals and distort the structure of the economy—penalizing genuine entrepreneurialism. In short, neoliberals expect that bureaucratic shakedowns and dysfunctional state fiscal, tax, labor, trade, procurement, and other policies motivate businessmen to support an opposition promising political and economic liberalization; Liberalism promises to be more profitable in the long run (Gould and Hetman 2008). There are several examples. While observing that companies that rely on favorable state policy for a profit generally collaborate with an illiberal regime, Andrew Wilson witnessed support for the politically liberal Orange Revolution in Ukraine among companies that had been forced by earlier reforms to compete for a living rather than to lobby for it. Faced with the op-

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portunity to build a better future, they risked the government’s displeasure by venturing support for the political opposition (Wilson 2005). Wilson’s observation raises a problem, however. Specifically, while the neoliberal explanation captures the contingency of agent behavior, it fails to account for the collective action problem inherent in any social movement (Varshney 2003). Competitive authoritarian and authoritarian regimes have many tools of control at their disposal; thus any businessman’s break with the regime is potentially dangerous. As Barbara Junisbai (2009) asks, open displays of disloyalty to the regime are somewhat of a puzzle. Why do businessmen take the risk? Junisbai’s answer is that that postprivatization entrepreneurs defect to the opposition when threatened with expropriation by the insiders surrounding the executive. In other words, defection is the last, best, and, hence, only rational option left open to them (2009, 2010). Irena Denisova and her collaborators document a similar conservatism among small entrepreneurs across a range of postcommunist institutional contexts: in an institutionally weak environment, entrepreneurs will not venture far in support for additional reforms on behalf of private property rights. To do so is to risk expropriation by local or national power brokers. Where, by contrast, there is a stronger institutional environment including greater legal protections, small entrepreneurs are much less timid and may openly support opposition candidates promising better institutions (2008: 5). My own work with Carl Sickner (2008: 749) complements the Junisbai and Denisova findings. Our focus, however, is on the effects that competitive authoritarian crises can have on the logics of economic actors. In a crisis, the long-term political future of the patron government may even be in significant doubt. Crises are thus moments of increased uncertainty (Blyth 2002; Rona-Tas 1997). They blur conceptions of friend and foe and produce shifting elite alignments (Ekiert and Kubik 1998: 571). Economic agents no longer take their cues strictly from the illiberal structure. They must make independent strategic choices to survive (Gould and Sickner 2008). Indeed, under conditions of crisis uncertainty, the risks of continued regime loyalty are potentially as great as the risks of defection. The best means of survival are no longer self-evident as the apparent benefits of loyalty to the regime disappear. This creates a brief possibility for “wide open collective action” (Ekiert and Kubik 1998: 571). Agents who previously equated defection from the regime with economic suicide now find defection and loyalty alike to carry fewer evident payoffs. At this point, the momentum of the opposition movement and signals sent by the opposing camps are important determinants of agent action. In particular, promises to

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reopen the books on past privatization and punish collaboration with illiberal governments are likely to reduce the number of defections (Gould and Hetman 2008; Gould and Szomolyáni 1997b). It is crucial to note that crisis-driven defection might occur as much for strategic political as economic reasons. Economic elites will fear being caught on the wrong side of a regime transformation. By hedging their commitment to the incumbent regime or by crossing lines to support its opposition, they may improve their position with the successor government if it emerges victorious. Switching allegiances might also buy them an “indulgence” for the “original sin” of illegitimate privatization and allow them to purchase continued insider access to public policy and legal goods (Frye 2006). Allegiance switching thus does not necessarily reflect a Coasian conversion to the principles of a market democracy; it may simply reflect a strategic gamble under conditions of high uncertainty. In short, while privatization under illiberal conditions usually fails to build a coalition favoring market democracy, it nevertheless instills agents with independent and dynamic logics of action. In crises, their actions become less structure-driven. Postprivatization agents can become, to misappropriate Eva Belin’s terminology, contingent market democrats (2000). One should not be too optimistic about the ability of economic elites to drive regime liberalization, however. One’s default expectation should be that major postprivatization actors in illiberal political settings will seek first to engage in some form of state capture, that is, the ability of firms to “shape the laws, policies, and regulations of the state to their own advantage by providing illicit private gains to public officials” (Hellman and Kaufmann 2001: 1). As demonstrated above, in illiberal political environments, those agents who are unable or unwilling to produce a competitive product may prefer an illiberal political environment that allows them to shape or benefit from regime policy. To summarize, even where liberal change would be good for their bottom line, postprivatization entrepreneurs tend to be quite conservative in their demands for institutional reform. They may have acquired properties by questionable means, stripped them of value, and protected their interests through often-criminal “private contract enforcers” (Hoff and Stiglitz 2005; Sonin 2003). All three choices were quite common behaviors for private agents in illiberal postcommunist Europe—all three would lead one to expect the agent to cast a skeptical eye at a movement promising liberal political change. In addition, there is the further threat that the state will use the administrative resources of the illiberal state to punish owners who support the opposition.

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Private owners in illiberal business environments tend to be poor Coasians. They tend to support reform primarily when driven to do so by the threat of expropriation (Junisbai 2009); when the property rights enforcement environment improves to a point where they can risk action in opposition to the government without being expropriated (Denisova et al. 2008); or where a regime crisis has made the political incentive structure so unclear that the risks of remaining loyal to the regime appear as uncertain as the risks of opposing it (Gould and Sickner 2008). In none of these cases do we find support for the Coasian political corollary that under illiberal conditions, privatization winners will lead the push for the rule of law and government accountability. Unfortunately, it appears that the primary liberalizing drive will have to come from elsewhere. In Europe’s competitive authoritarian regimes, well-organized regime oppositions and social movements have played this role, with the market-oriented business sector providing only contingent support.

Conclusion

An illiberal postcommunist political pattern reinforces itself as it progresses—up to a point. Illiberal, insider privatization, unfortunately, plays a catalytic role in the process. Insider privatization under illiberal political conditions can stifle demand for an environment conducive to Coasian contracting. Far from restructuring and demanding the rule of law, politically connected owners often demand exemptions from public policies that guarantee they will do well. Since minimal accountability and the politicized application of the rule of law will help them protect these benefits, illiberal insider privatization creates a vested interest opposing additional reform. Regime politicians, bureaucrats, and rent-seeking businessmen alike thus have an incentive to maintain the illiberal equilibrium. Meanwhile, the state has administrative resources that officials can use to punish dissident, proliberal entrepreneurs. This helps ensure proregime discipline among their ranks. Privatization under liberal political conditions, by contrast, has a greater potential to reinforce liberalism. Sometimes a weak institutional environment will promote the sorts of insider conspiracies that Smith worried about, but under liberal political conditions, these conspiracies are more easily identified and eliminated. It is no accident, for example, that the postprivatization scams we will examine in illiberal Ukraine cost more and lasted longer than in the relatively more liberal Czech Republic. Slovakia also won

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its battle to eliminate privatization-related scams in relatively short order— five years—but privatization winners fought so hard to establish and preserve their position that it temporarily cost the country its democratic credentials. For those still laboring under the twilight institutions of competitive authoritarian regimes, there is a ray of hope: Competitive authoritarian regimes can be crisis-prone. When these regimes do slip into crisis, the barriers against collective action fall, and postprivatization economic agents are forced to think strategically about how best to preserve their interests under uncertain conditions. If an opposition plays its cards right, it can succeed in drawing these agents into a coalition supporting political and economic liberalization. Chapters 4 through 8 document our cases.

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4 Privatization Design in Czechoslovakia, 1990–1992

Property is a terrible thing and sometimes leads to unruly behavior. —JÁN DUCKÝ, SLOVAK MINISTER OF THE ECONOMY

he term privatization framework captures privatization’s distributional dimension. This term reflects the insight that some interests will benefit more from a privatization program than others. By distinguishing between outsider and insider access to a privatization program, the privatization framework concept offers one way to determine who benefits from the distribution of state property in postcommunist societies. It thus helps scholars investigate possible sources of material conflict within societies. In postcommunist societies where most property is state owned, the answer to this question carries high stakes and is likely to interact in significant ways with politics and the development of political institutions. The previous chapter predicted that illiberal political conditions are likely to produce insider privatization frameworks—ones that allow incumbent position holders and their allies to emerge as privatization winners. Since political competition is threatening to the insiders’ privileged political position, insiders may even seek to weaken political institutions to improve their chances of winning the battle over property distribution. Under liberal political conditions, by contrast, insiders are likely to secure influence over the privatization framework only where they played a positive role in the reform or breakdown of the previous communist regime. The case of Czechoslovakia and its subsequent breakup is a good place to begin to investigate the politics of privatization’s distributional dimension and the privatization framework. Privatization began in Czechoslovakia as a federally designed program, with nearly identical implementation at the

T

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Slovak and Czech Republic levels. Yet following the official breakup of the federal state at the end of 1992, Slovakia initially delayed and then cancelled the second-wave voucher component of its privatization program. Meanwhile the Czechs administered the second wave with only minor changes in emphasis. Chapters 5 and 6 explain why the Czech and Slovakia patterns diverged. This chapter describes how the privatization framework developed. Czechoslovakia emerged from communism with a relatively robust set of initial democratic political institutions and an embattled and weak postcommunist left. This would lead us to expect that Czechoslovakia’s dominant privatization framework should reflect outsider interests, rather than managerial insiders, employees, or former apparatchiks. As we shall see, this is indeed what happened. Czech and Slovak bureaucrats, managers, and trade union leaders emerged from the communist era highly compromised by their association with the hard-line communist regime. They did poorly politically in the liberalizing democratic conditions of the early postcommunist period. Privatization planners thus had little trouble subordinating insider interests to other concerns in the design of the privatization program. The first section of this chapter tells this story. The second section describes how federal reforms interacted with Slovakia’s politics and helped formulate the eventual political lineup that broke up Czechoslovakia. Czech enterprise managers, trade unionists, and apparatchiks remained weak due to the ability of reformers to discredit their demands as a form of communist backsliding. Slovakia’s managers and apparatchiks, by contrast, found portable skills originating in popular nationalist concerns about Slovak identity. By associating themselves with those politicians promising to promote the interests of the Slovak nation against a Czech-designed, neoliberal reform program, former communistera managers and apparatchiks were able to establish new legitimacy in Slovakia’s competitive politics. Their support helped Vladimír Me¸ciar, a politician aligned with many enterprise managers, to form a government after winning a plurality in the summer 1992 elections.

Establishing the Czech and Slovak Privatization Framework The Discredited Left

The weakness of managers, trade unionists, and apparatchiks after the Velvet Revolution reflects the communist regime’s success in repressing civil

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society and the reform of communism following the August 1968 Warsaw Pact invasion. By spring 1969, hard-line central planners had reasserted tight control over the economy, including setting prices higher to reduce consumption and any significant need for foreign borrowing.1 With access to cheap Soviet energy in the 1970s, the Czechoslovak economy settled into relative balance. Unlike Poland, the government never had to ask its citizens to make notable sacrifices to cut expenditures. Czech citizens never had the Poles’ chance to deny the government’s demands for general cooperation; Czech communists never gained Polish communists’ skills in negotiating with the opposition or administering reforms. From 1969 to 1989, regime stability, strict communist orthodoxy, and a marked absence of any form of widespread, well-organized societal challenge to authority characterized Czechoslovak politics. This period of normalization had a devastating effect on the postcommunist viability of the official left. Trade unionists, enterprise managers, and party apparatchiks had been wholly subservient to the hard-line, antireform communist leadership. All initially resisted the demonstrations in fall 1989; and in the early days following the Velvet Revolution, they had virtually no legitimacy in Czech politics. Over the course of winter 1990, the revolutionary movements—Public Against Violence (VPN) in Slovakia and Civic Forum (OF) in the Czech Republic—induced significant turnover among the Communist Party’s leading industrial managers and bureaucrats (Clark and Soulsby 1996: 285–303).2 Within enterprises, OF and VPN organized workers’ committees at the shop floor level, which then voted on the competence of top management and union leaders. The postcommunist Government of National Understanding also dismissed managers and leading bureaucrats after taking control of their federal branch industrial ministries. Early retirement incentives and a political cleansing process called lustration contributed further to the shift in control of enterprises from communist-era appointees to an ascendant group of middle managers and apparatchiks.3 Dismissals sent a strong message to the middle managers who stepped into top management positions in 1990. Those who resisted liberal change risked becoming associated with an antimarket backlash and obstructing what OF and VPN leaders called a return to Europe. New managers thus took great pains to avoid the appearance of opposing reforms. The lack of political viability among the old communist left created space for a new left, consisting largely of purged communists from the Prague Spring era—commonly referred to as ’68ers—and some dissidents from the Charter ’77 movement. Charter ’77 was a group formed in 1976

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by Václav Havel and others to pressure the communist government into upholding its pledges to respect human rights (Orenstein 2001; Schwartz 2006). In addition, a number of communist politicians had joined the Velvet Revolution and been included in the Government of National Understanding in December 1989. Many within these groups had strong social democratic leanings and were an important voice in early policy. Later, they were elected in large numbers to the three federal- and republic-level governments that took power in June 1990, where they often advocated movement toward Western European forms of social democracy. In particular, they sought to create a tripartite negotiating forum among the government, businesses, and workers to maintain solidarity between classes and social peace as the government dismantled Czechoslovakia’s centrally planned economy (Malová 1997; Orenstein 1996a; Rutland 1992).4 In fall 1990, as part of this project, the government urged industrial managers to create three Confederations of Industry—one each in the Slovak and Czech republics and another at the federal level—to represent the interests of enterprise employers in talks with the government and trade unions. Trade unions organized along similar lines (Rutland 1992: 121). Trade union officials and managers thus had formal and informal mechanisms that could potentially aggregate and articulate their views to the government. Theoretically, at least, they should have been able to carry some weight in discussion over economic reforms (Malová 1997: 100–106). Yet, this impressive organizational coherence did not lead to significant policy influence. Despite a mutual interest in a more activist state policy toward restructuring state-owned enterprises, the new left forces—’68ers, social democrats, and dissidents—and old left forces—trade unionists, industrial managers, and former party bureaucratic holdovers in the ministries—could not overcome their mutual distrust. Nor were new union leaders any threat to social peace. Discredited by the unions’ communist past, they had no ability to threaten strikes should negotiations go poorly for workers. It soon became apparent that the government was the dominant partner in tripartite talks. Indeed, the federal government succeeded in obtaining agreement to the tightest restrictions on wage increases in Central Europe. In 1990, with inflation topping 60 percent, real wages declined 26 percent with no noticeable trade union action (Orenstein 1996a: 178, 184–185; Rutland 1992: 118–128). Designing Reforms

With insiders forced into retirement, demoralized, or suppressed, a group of mostly Czech economists argued at length over the timing and intensity of

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economic reform measures—including privatization. Similar to the discussion in Chapter 2, these economists fell into gradualist and radical neoliberal camps. The main champion of radical reforms was Václav Klaus. Under communism, Klaus had worked in the now-famous Prognostics Institute. This was a low-profile research institute within the Czechoslovak Academy of Sciences that functioned as a sort of sanctuary for nonorthodox speculative thought under communism. Klaus and others had used this quasi-official space to train themselves in contemporary market prescriptions for transforming state-directed economic systems into free market economies. By 1989, Klaus was a passionate advocate of the neoliberal reform orthodoxy later referred to as the Washington consensus. Neoliberals like Klaus made one exception to their faith in free market forces: to fight inflation, wage increases must be capped at a rate lower than the general level of price increases. Not surprisingly, this made them somewhat hostile to organized labor. Klaus and his more reform-minded, communist-oriented institute director, Valtr Komárek, emerged during the Revolution to become leading public figures (Garten Ash 1990).5 Klaus impressed the dissident intellectuals in Václav Havel’s circle with his strong analytical mind and well-formulated conceptions about how to reform the economy.6 In the rush of events, Klaus’s evident competence earned him the top post in the federal Ministry of Finance in the new government. Other neoliberals were also launched into power. Vladimír Dlouhý, who had been Komárek’s number two at the Prognostics Institute and a Communist Party member, took over the Office of Central Planning—if only to close it. Economists Dušan T¸ríska and Tomáš Ježek also took roles in the new government. Less radical, gradualist economists from the new left also moved into power. Komárek became the federal deputy prime minister in charge of the economic transition—the second highest-ranking member of the new postcommunist Government of National Understanding. The Velvet Revolution also brought into power a flood of 1968 veterans. For many, the determining experience of their lives had been the attempt in 1967–1968 to bring “socialism with a human face” to Czechoslovakia (Innes 2001: 31). The 1968 veteran economist Otakar Turek pointed out that in winter 1989–1990 there was a good deal of continuity in their contemporary economic thinking. Hence, while most of the new political elite explicitly hoped to dismantle central planning and adopt the market mechanism as the chief mode of economic allocation, many, like Komárek, hoped to find ways to “temper the extremes” of “unfettered” capitalism.7 The veterans of 1968 also had the ear of Havel, the newly appointed president. Havel was highly suspicious of Klaus’s radical economic ideology; apparent opportunism; and self-confident, arrogant personality. As

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president, Havel took economic advice from another Prague Spring economist, Richard Wagner, and later from Ota Šik, who had been deputy prime minster from 1967–1968). Beyond the ’68ers, a number of high-ranking communist officials made the transition into the new government. The position of federal prime min¸ ister went to Marián Calfa, a Slovak communist who had crossed lines in the early stages of the Revolution with great agility. The former communist ¸ c, became Slovakia’s republic-level prime minminister of justice, Milan Ci¸ ister. These leading political officials also had gradualist leanings, as did the former Czech dissident and Havel associate, Petr Pithart, who took over the role of Czech prime minister. As the need for decisive action began to weigh in on the new government, the radical and gradualist camps diverged. Klaus responded to newleft rhetoric about a “third way” and a “social market economy” by advocating “a market economy without any adjectives.”8 He publicly heaped scorn on the ideas of his rival economists. Despite the rancor, the leaders of the postrevolutionary government sought to retain a united front and put pressure on the economists to come up with a compromise proposal for economic reforms. Klaus gathered a formidable team of neoliberal-oriented economists, many of whom had emerged from the Prognostics Institute, and created a radical scenario for reform during their spare time on weekends.9 By contrast, Komárek inexplicably left for an extended tour of the United States (Husák 1997: 108–110). By the time he returned, the Klaus team had put together a coherent neoliberal structural adjustment package based on price liberalization, austere fiscal reductions, and monetary restraint. They also promised wage and pension caps at a level below inflation; currency devaluation and full convertibility; trade liberalization; demonopolization; and a rapid, popular mass privatization program based on the untried concept of free distribution of privatization coupons to the adult public. Gradualists feared that Klaus’s radical scenario was going too far. In April 1990, former dissident and Czech Republic–level prime minister Pithart authorized his deputy prime minster, František Vlášek, to assemble a team of like-minded economists to develop an alternative to the Ministry of Finance’s radical scenario. The Vlášek team consisted “generally [of] followers of professor Šik,” who “shared similar biographies,” including being purged from the Communist Party following the Warsaw Pact invasion (Turek 1990: 56–57).10 The Czech Plan, as it came to be labeled, called for a milder macroeconomic stabilization plan and offered two alternative proposals on trade liberalization—one of which was quite similar to the neoliberal plan.11 On privatization, they objected to the Klaus program of rapid

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privatization and market-driven enterprise restructuring. Instead, they proposed to adopt the German approach of a rapid corporatization of firms with the shares to be held by a new national property fund—vaguely expected to resemble the German Treuhand, the state property management body created to restructure and privatize former East German enterprises and vested with enormous resources and powers. For each firm, the fund would select a board of supervisory directors who were responsible for management strategic vision and supervision. The newly imposed supervisory oversight and harder budget constraints would force managers to undertake changes that would make the firms optimal for privatization. Whether the fund would be outsider- or insider-focused would depend on the fund’s implementation.12 Klaus and the ministry team were initially appalled at the idea of a national property fund, preferring to cut, rather than reshape, state-enterprise ties. According to Ježek, “We recognized that a fund that would be created under this concept would have the character of some sort of planning commission—a sort of center of economic power” (Husák 1997: 110). Pithart asked Vlášek to work with Klaus to reconcile the two plans. Karel Kouba and another team member met with Klaus to hammer out a compromise. According to Turek, however, Kouba ended up by giving in to Klaus on almost every particular except for the privatization fund.13 Kouba, however, prevailed on the concept of a national property fund and the group duly incorporated it into the design of the Klaus team’s mass privatization voucher scheme. A second compromise related to the new title of the Privatization Ministry.14 While the Czech government and the federal Ministry of Finance hammered out their differences, Komárek’s lack of leadership in the war of ideas with Klaus at the federal level led Havel to replace him as deputy premier with Václav Valeš in April 1990. Valeš was a ’68er with strong connections to state enterprise industry and insights into the incentives facing industrial managers. Within a month, he produced an alternative gradualist scenario for reform and presented it to the federal government along with Klaus’s slightly compromised version. Much of Klaus’s popular appeal was that he represented, and purported to offer, a complete break with the communist past. He had rejected 1968 reforms as an effort to save communism. Now he used this absolutism to tar all his opponents with the same brush of ignominious compromise with impure economic thought and suspect moral and political values. Klaus thus attacked the heart of the new left’s ideology. To the great dismay of his ’68er opponents, he made virtually no distinction between the reform communists of Prague Spring and the

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stalwart hard-liners of the 1970s and 1980s. Grouping ex-dissidents into the same category as their former tormentors was undoubtedly galling to Klaus’s opponents, but it had a certain appeal among neoliberal students of Friedrick Hayek, who felt that the state controls necessary to implement social market democracy were merely a step back toward authoritarian political control (Appel 2004; Hayek 1944). Indeed, Klaus portrayed any attempt to use the instruments of the state to ease the transition as an attempt to reestablish the command economy and authoritarianism. In this, he found a highly sympathetic audience in London and Washington. As he told the Institute of Economic Affairs in London, a transition to a market economy “requires an abandonment of perestroika, not its realization. . . . They want to organize sophisticated government programs; build infrastructure and dominant industries; pick winners and losers; ask for massive Western financial assistance (and especially distribute it); help firms in distress; dictate prices, interest rates, and exchange rates . . . simply they want to centrally plan.”15 Klaus’s polarization of the reform discourse obscured the reality that he began to make compromises that were necessary to ensure that his radical scenario would get through federal parliament. In the late spring of 1990, Klaus fully incorporated the gradualist scenario for social policy drafted by the left-leaning federal minister of labor, Petr Miller. As Mitchell Orenstein points out, the result was “radically neoliberal in macroeconomic policy and social democratic in its approach to labor relations and the welfare state” (2001: 72). The compromises enabled the coalition of Revolution forces to unite behind a single program of largely radical reform. In the founding June 1990 parliamentary elections Havel led OF behind the slogan, “A Return to Europe.” In Slovakia, VPN tellingly campaigned under the slogan of “A Chance for Slovakia.” The movements won a plurality of the vote at both the republic and federal levels. Slovakia’s new Christian Democratic Move¸ ment (KDH), founded by former religious dissident Ján Carnogurský, also did quite well. Following the election, this constellation of postcommunist movements had little trouble forming ruling coalitions in both republics as well as in the federal government. The election could hardly be called a referendum on the Klaus package of reforms, however. Public understanding of what reforms would actually mean in practice was still quite poor (Orenstein 2001: 73; Szomolányi 1994). While OF took advantage of sentiment in favor of a European identity, Klaus argued that only radical reform would promote this identity. Klaus rhetorically granted no middle ground. As he put it, only radical reform would prevent Czechoslovakia from repeating “the mistakes of the

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1960s, when we attempted to introduce a hybrid system between central planning and market economy. . . . The third way is the fastest way to the Third World.”16 As Komárek later stated, Klaus reduced the debate to starkly opposed choices of “either liberalization or a centrally planned economy, either swift privatization or a threat of a communist revival.”17 Behind such polarizing and uncompromising rhetoric, in fall 1990, Klaus defeated Havel’s handpicked candidate for chairman of OF, the former dissident Martin Palouš. The defeat of Palouš foretold the eventual breakup of OF. Klaus had won the support of OF’s pragmatists in the local district committees. These local officials were allegedly more concerned with getting on with the business of running the government—and in some cases building their personal wealth and power—and reforming the economy. They felt less tolerance toward the moral personal objectives and the sermonizing of the dissidents. In February 1991, OF split into factions with the liberals, anticommunists, and pragmatists forming the Civic Democratic Party (ODS) and a Havel-dissident-centered rump forming the Civic Movement (OH).18 At the same time, Klaus derived political benefit from the politics of anticommunism and developed a natural alliance of mutual self-interest with liberal anticommunists like Jan Ruml, the minister of the interior (Appel 1998: 219–222). Ruml pushed for a strong lustration policy to rid the government and state economic sector of politicians who had cooperated with the communist secret police. While Havel and other dissidents resisted full lustration as an unjust form of collective punishment—or guilt by association—Klaus supported it. Not only was it a means of reducing the strength of his left-leaning rivals among ex-communists with gradualist leanings, but it also allowed Klaus to build a new base of support among a new generation of politicians who literally stepped around or over communist-era elites implicated in the lustration process.19 Hence from the start, Klaus’s proreform coalition was based, at least in part, on the opportunistic loyalty of cadres who owed their careers to the anticommunist politics associated with the Revolution. Klaus’s renowned pragmatism reflected a stark political realism: the willingness to provide material benefits to his followers and clients. Beyond being a party of radical reform, Klaus’s ODS had a ruthlessly pragmatic political and even clientelist nature; it aspired to be the party of power. Designing Czechoslovakia’s Privatization Framework

The Velvet Revolution put outsiders in control of economic policy planning. Insiders, particularly enterprise managers and employee representa-

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tives, found they had little direct political influence in the design of the federal economic reforms that resulted. Yet the final program was not entirely hostile to their interests. This was the unforeseen and unintended consequence of the social democratic leanings of ’68ers and dissidents in power. Neoliberal economists, of course, favored privatization. Given the freedom to do what they pleased with their enterprises, they believed that private owners would make the difficult decisions necessary to generate a supply-side response to the constraints and opportunities posed by macroeconomic stabilization, liberalization, and other aspects of structural reform. Yet, beyond economic prescriptions, Czechoslovakia’s privatization framework had explicit, if not overriding, political objectives. First, the primary architects of the large-scale privatization program, Klaus and T¸ríska, deputy minister of finance, sought to generate a citizenry with a material stake in the transition to provide a counterweight to the expected political backlash from the traditional losers of economic reforms. Klaus also presumably hoped that this support would translate politically into support for OF and later for his own nascent political party, ODS. Second, T¸ríska and Klaus intended to implement a swift privatization program that would quickly remove old communist management and bureaucrats from control. The hope was to privatize control of the firms before these groups had a chance to organize and demand comprehensive privileges in the privatization process (T¸ríska 1991a). At the same time as Klaus and T¸ríska contended with these formidable political challenges and goals, they also faced two crucial technocratic barriers. First, private enterprise accounted for only 4 percent of gross domestic product (GDP) in 1989. It would thus require an enormous privatization project to develop even a rudimentary private sector. Second, individuals in the Czech lands and Slovakia lacked the savings to buy state firms, while a wholesale sellout to foreign suitors would have been politically untenable. Dlouhý, Czech minister of trade and industry from 1992 to 1998, later estimated that given citizens’ level of savings, selling them enterprises at book value would have taken up to 600 years (Dlouhý and Mládek 1994: 156–157). The concept of a mass privatization scheme surfaced as a solution to the political and economic needs of the reformers. It would provide a wide range of citizens with a stake in the Revolution, and it would remove insiders from control of industrial enterprises. At the same time, it promised to make possible the rapid transfer of government assets into private hands without requiring the primary recipients to come forward with great sums of cash.20 Klaus and his privatization team thus decided to go ahead with mass privatization. But transferring ownership to citizens meant not transferring it

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to enterprise insiders, management or employees, or even apparatchiks. Klaus expected their opposition. While neoliberals are usually indifferent as to final owners, Klaus and his colleagues felt that too many of the managers appointed after the 1968 invasion were still in place. They believed that these managers had been selected for their reliability as political overseers rather than as capable technicians or businessmen, and that this older generation was simply incapable of transforming their enterprises under market conditions.21 As a first step, Klaus’s federal Ministry of Finance commercialized all state enterprises. Each company issued equity stock controlled by either their founding industrial ministry or one of three new quasi-state bodies, the National Property Funds (FNMs). The Slovak FNMs held firms headquartered in Slovakia; the Czech FNMs held those with seats in Prague, and ¸ the federal FNMs held federal firms like CSA, the state-owned airline. The company would then be administered through an executive board appointed by the stockholders—generally the FNM or the relevant industrial ministry—and a supervisory board consisting of a mix of appointees nominated by the FNM and the employees. Perhaps most importantly, the government would then appoint the management of the FNM. Each government now, in theory, retained the indirect ability to appoint and monitor enterprise directors pending privatization. Commercialization thus held out the promise of serving as a safeguard against spontaneous or nomenklatura (the entrenched party-administrative class) privatization of enterprises, which had occurred in poorly monitored state firms in Poland and Hungary (Frydman and Rapaczy´nski 1994: 154– 155). More importantly, it also prepared the way for privatization. All the state had to do was decide the framework by which the FNM or ministryowned shares in an enterprise would be transferred into private hands. Given the ideological differences between gradualists and radicals over industrial policy, the federal government quickly split over what kind of control to exercise over commercialized enterprises. Klaus and T¸riska took the strict ideological stance that the government could not run or restructure an enterprise. State control had been the problem in the first place. As good neoliberals, they felt the task should be to get private property into private hands as quickly as possible.22 This implied a largely passive FNM role in corporate governance and hands-off industrial policy. Yet Vlášek’s team originated the concept of the FNM to provide a tool for enterprise restructuring prior to privatization. Similarly, the federal minister of industry, Jan Vrba, hoped to use state control for restructuring to entice strategic investors to buy large blocks of the companies on more favorable terms. From 1990 to 1992, the ministry engaged in a number of

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high-profile public tenders—the most notable of which was the sale of the Škoda’s automobile division to Volkswagen Group (Appel 2004: 139; Schwartz 2006: 144–145).23 Klaus and his team began to prepare a privatization plan that would facilitate the rapid turnover of corporatized shares to citizens in a mass giveaway. Initially, the chief architect and proponent of voucher privatization, T¸riska, fought for a scheme that would privatize 97 percent of corporatized firms’ shares in a mass giveaway to Czechoslovak citizens. Others could then participate in a massive secondary market for enterprise shares. The remaining 3 percent would go to a Restitution Fund to compensate property owners who had lost properties under communism that the state could not physically return.24 Ježek objected to the inflexibility of the 97+3 plan, arguing that the economy would benefit from having more options, including the ability to include a strategic outside or even foreign investor directly into the privatization plan. Ježek also argued that the program should allow rivals to offer competing privatization plans. In short, Ježek sought to replace T¸ríska’s plan for a streamlined, quick transfer of assets to citizens with a more cumbersome program. It would not only permit a wider range of outsiders to participate immediately, but also would give the incumbent managers the opportunity to propose privatizing to themselves! After fierce debate within Klaus’s camp, T¸ríska’s plan gave way to Ježek’s more complex vision. Ježek, in turn, subsequently found himself demanding an extended timetable to allow his more complex scheme to work (Dlouhý and Mládek 1994: 156–157; Schwartz 2006: 144–145).25 From one perspective, Ježek’s amendments could be interpreted as a major concession to managerial insiders who now could propose to buy their own company’s shares. Yet, T¸ríska and Klaus’s associate and chief capital markets regulator, Vladimír Rudlov¸cák, both assert that industrial managers remained weak, disliked, and distrusted. T¸ríska felt a leadership role for managers would be “absolutely unacceptable.”26 Nor did Klaus and T¸ríska admit to feeling any pressure to win the managers’ support by making concessions (Appel 2004: 53–60). Yet, without Ježek on board, Klaus realized he would have greater difficulty getting the proposal past the gradualists in the federal and, particularly, the Czech governments. Pragmatically, he gave in. T¸ríska and Klaus were more concerned with speed. To use the Czech neoliberal’s oft-repeated imagery, their aim was to get the shares into private hands as fast as possible and then “turn out the lights” as the real battle for ownership concentration and control of firms began.27 As we shall see in Chapter 5, this desire for speed over an enabling legal framework would mean that private prop-

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erty would emerge without adequate institutions to support ownership. This had grave adverse effects. T¸ríska lost the fight to Ježek, but won the larger battle. Due to turnover within enterprises, the most unacceptable cadre of political appointees from normalization were giving way to the younger, potentially more capable generation of managers. These were part of “the lesser nobility of communism” who had often been, at least privately, highly critical of communism and who showed signs of being able to adapt economically and politically to the new conditions (Baylis 1994: 315). Thus, in an effort to retain a speedy privatization program, T¸ríska and Klaus permitted concessions that would allow insiders to include themselves in the transfer of shares into private hands. This helped assuage the deeper fears of middle managers as they stepped in to try to give their firms direction under tough new conditions. It must have also whetted their appetites. With a crucial compromise made, Klaus and T¸ríska now faced the challenge of convincing incumbent managers to elect to transfer a significant portion of their firms’ shares through the voucher program. They did this in two ways: (1) they explained to managers that citizen voucher ownership would quite likely be widely dispersed, leaving the managers in position to wield effective control with a relatively small stake; and (2) they pointed out that the process would be competitive and that the respective ministries of privatization would likely select only those privatization plans that privatized a large portion of company shares through the voucher program.28 While managers would probably have preferred direct sales to the incumbent management, they had no choice but to accept the government’s privatization plan (Appel 1998: 97). The final voucher privatization framework worked as follows: The Slovak, Czech, or federal privatization ministries would announce that a state enterprise would be privatized and order the incumbent management to submit a privatization plan by a given deadline. This would be called the base privatization plan. A second deadline would then be set for competing plans that could be submitted by any other interested party. If the relevant governing body selected the incumbent management’s plan over its competitors, management would have a significant say over how their enterprises would be privatized. Incumbent managers had a range of modes by which they could propose to transfer enterprise shares to private hands. In addition to vouchers, possible methods included a direct sale of shares to a predetermined buyer, public auction, or a competitive public tender. Yet, the appearance of freedom of choice was often illusory: Klaus had led most to believe that they would only succeed if their plan included a large voucher component.

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Labor proved to be even less of a barrier to privatization than management. Klaus argued that workers would benefit through the voucher process as ordinary citizen-shareholders. Nevertheless, labor and management, ¸ backed by the Social Democrats (CSSD), fought for an employee buyout program allowing them to buy up to $1,018 worth of shares in their company at a 50 percent discount over a period of ten years. Five thousand employees even signed up for the program and paid the first 1,000 koruny (US$35) installment. Klaus rejected the program in early 1991. Instead, the government suggested that the employees use their first payment to buy voucher booklets (Olsson 1999: 221). Legislation even limited employee shares in a privatization plan to a maximum of 10 percent. This was later reduced to 5 percent in the Czech Republic. “T¸riska’s project” came up for discussion in federal parliament in fall 1990. It faced, according to Rudlov¸cák, the “ideal situation” for passage: the key concessions had already been made and Klaus’s campaign to associate his opponents with a return to some form of watered-down communism had a devastating effect on political debate. As Rudlov¸cák observed, the new left’s voice remained unorganized and even suggestions from former dissidents “were often seen as Bolshevik.” This allowed discussion in parliament to remain “technical and unpoliticized.”29 Despite T¸riska’s concessions to Ježek and enterprise managers, the bill, known as the federal Large Scale Privatization Act (CSFR Act 92/1991), provided the weight of its distributional advantages to outsiders. Ministries and managers would have to cede significant control of enterprises to a new class of citizen: the voucher holder. Who these citizens would be and how they would exercise their property rights remained entirely unclear. The bill passed into law in February 1991 (Appel 2004; Orenstein 2001).

Radical Reform and the Return of the “Old Left” in Slovakia

Slovakia’s insiders emerged from the communist era with many of the same democratic liabilities as their Czech counterparts. Bureaucrats, managers, and union leaders alike suffered from their association with the communist regime. Moreover, the umbrella revolutionary movement, the VPN, actively dismissed top communist ministers, union leaders, and industrial managers.30 In contrast to Czech insiders, however, Slovak industrial managers and apparatchiks had a range of potential allies as a result of a broader debate over Slovak national identity and the distribution of power between federal- and republic-level institutions. The potential for Slovak industrial

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managers and former communist apparatchiks to regain policy influence began to emerge as early as winter 1990 in the area of defense policy. The federal-level Government of National Understanding, in power from December 1989 to June 1990, inherited its defense policy direction from the former communist government, which had begun conversion to civilian production in 1988 (CSFR Resolution 159/1988). A few months later, the communist government reduced production of tanks with a plan to phase them out (CSFR Resolution 84/1989; Outrata 1992: 87). This boded poorly for Slovakia’s heavy-weapons producers. In January 1990, federal foreign minister Ji¸rí Dienstbier, a Czech Charter 77 dissident, scaled back exports of arms to politically suspect locations like Syria and Iran (Jefferies 1990: 390). President Havel took a typically principled stance, declaring, “Arms production and profit from its products by the state is an amoral act.”31 Parliament similarly passed a resolution (CSFR Resolution 42/1990) demanding a halt to weapons exports and the conversion of costly weapon lines like armored infantry vehicles, large-caliber artillery and ammunition, and antitank missile systems. The producers of these Czechoslovak products were located primarily in the Slovak Republic, along the Vah River (Outrata 1992: 87). The actions of the new government mobilized Slovakia’s industrial producers, who saw the federal government’s new alignment with the West as a primary cause of their own decline. The managers felt that this naively played into the hands of Western defense industries—the “interests” that “stood behind” the “new world order.”32 In Czech politics, calls from communist-era industrial leaders to export weapons to a pariah state like Syria were easily brushed aside as the last howls of an outmoded, dying, and irrelevant group of communists. In Slovakia, however, bureaucrats and industrial managers could portray it as a Czech attack on a viable Slovak industry. They found an audience among nationalists willing to assign anti-Slovak motives to the federal government’s policy: Czechs, they argued, would not do this to their own industry. One of the first public officials to pick up on the defense industry’s concerns was Jozef Markuš, a Slovak economist from the Prognostics Institute. As a prognostic, Markuš was VPN’s choice for Slovak deputy prime minister in the republic-level Slovak parliament from December to June 1990. Markuš played a limited part on Klaus’s federal reform drafting team and largely sided with Klaus on technical reform issues. He differed, however, over their administrative location and his desire to have a greater Slovak voice in implementation. In particular, he argued, the Slovak government should have determined Slovak policy for the Slovak defense industry.

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Markuš had little to no impact on the broader discussion over reforms, but his growing pro-Slovak national stance brought him into conflict with the VPN’s former dissident leadership.33 These were Slovak intellectuals like Fedor Gál, Ján Budaj, Miroslav Kusý, and Milan Šime¸cka who were associated with Havel, Charter ’77, and the fight for civil and political rights under communism. Nationalists like Markuš increasingly took it as an article of faith that the dissidents had a Czechoslovak view of the Slovak-Czech relations that placed federal needs above parochial Slovak concerns. This allowed Slovakia’s industrial managers, particularly in the engineering and defense sectors, to claim victimization at the hands of the federal government and the ex-dissident wing of VPN. Beyond Markuš, the most politically active Slovak economists in the early reform period were Rudolf Filkus and Jozef Ku¸cerák.34 Following the June 1990 election, Filkus became minister for economic strategy in the VPN-dominated cabinet of Slovak prime minister Me¸ciar.35 Like Markuš, Filkus considered himself a market economist. In practice, however, he supported strong central intervention to stabilize employment and production while reforms took hold—particularly in the heavy industrial, engineering, and defense sectors. Filkus was not a strong nationalist, but he attempted to tread the line between retaining some neoliberal reform principles and advocating active state intervention to address the specific weaknesses of the Slovak economy (Filkus 2006: 63–65). Neoliberal critics might have felt this was bad economics, but in Slovakia, it was good politics. Filkus’s Slovak-oriented gradualism contrasted sharply with another politically active Slovak economist in the post-1990 Slovak cabinet, Ku¸cerák. Ku¸cerák was Slovakia’s leading neoliberal economist after the Revolution. He was a purged 1968 communist who, like Klaus, had rejected Šik’s mix of market reforms as too timid. During normalization, the Communist Party shunted him into a Slovak Academy of Sciences research institute that served as an academic cage for distrusted social scientists. Here, he formed a close relationship with future VPN leader and sociologist Gál. In the late 1980s he also developed a relationship with Klaus and was in Prague at the Prognostics Institute, working on a project with Markuš, when the Revolution intervened. The Revolution propelled Ku¸cerák into the federal parliament, but after the June 1990 elections, he replaced Markuš as Slovak deputy prime minister.36 Despite being on the same page as Klaus on the neoliberal agenda, it was Ku¸cerák who initially spearheaded Slovakia’s discussions with the federal government and the Czech government on transferring the lion’s share of economic policymaking tools from the federal government to the republic governments.37 His willingness to recognize some need for policymak-

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ing devolution demonstrates the degree to which, right from the start, unqualified support for the federal status quo was outside the range of Slovak thinking on economic policymaking. The ability of Slovaks as diverse as Filkus, Ku¸cerák, and Me¸ciar to rally behind Klaus’s reform package in summer and fall 1990 was made possible at the federal level by the compromises on social policy between Klaus and Miller. In the 1990 election, VPN used this compromise to imply that radical economic reforms would bring minimal transitional pain (Szomolányi 1994: 72; Žiak 1998: 140). VPN’s reform fiction also had the effect of allowing Slovaks to focus on identity issues. Markuš’s early 1990 call for greater direct Slovak control over defense conversion policy quickly gave way to an enormously publicized debate in the federal Assembly over the appropriate name of the country. The Assembly finally settled on the Czech and Slovak Federative Republic, but not before former civic dissident leaders of the VPN dismissed the initiative as a communist plot designed to drive a wedge between the revolutionary Czech and Slovak movements (Šiklová 1996: 57–62). The simple desire to hyphenate the official title of the country moved from a minority communist initiative in the Slovak National Council (SNC); to an SNC resolution; and then to a bitter, but revealing, debate in the federal assembly. The intensity of passions clearly indicated to Slovak political elites that there were dangerous implications in being caught on the wrong side of the national issue. In April 1990, former religious dissident and chairman of the Christian ¸ Democratic Movement (KDH) Carnogurský raised the stakes by stating: “Europe is headed toward integration. When it becomes a reality one day, we would like to join it as an independent subject.’’38 While he quickly qualified his statement by asserting that the integration of the Czech and Slovak economies made separation unrealistic in the foreseeable future, ¸ Carnogurský’s position at the head of Slovakia’s most prominent political movement outside of VPN put VPN’s leadership under significant pressure to stake out its own position. In repeated polls, an overwhelming 70–90 percent of Slovaks did not favor independence. However, a significant majority was also unhappy with the state of Czech and Slovak institutional, economic, and social relations as they stood at that time (Wolchik 1995: 235). Meanwhile, Slovak separatist movements and cultural clubs began to form at the margins with civil actions oriented around a loosely assorted list of ethnic nationalist and often ethnic chauvinist causes. VPN’s June 1990 platform, called “A Chance for Slovakia,” attempted to stake out a political middle ground between fringe separatists and the

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broader fear that the VPN was dominated by the Prague-centric views that many associated with some of its dissident leaders. While endorsing radical reform, the VPN also included demands for devolution of some federal powers to the republic-level governments. Czech government negotiators were shocked by their Slovak governmental counterparts’ obsession. As one Czech economist recalled, the Slovaks ignored questions over the speed and intensity of reforms in favor of “existential questions” such as “whether there should be within the federation one ‘single’ economy or a ‘shared’ economy.” The debate between Klaus and Komárek seemed to have entirely passed the Slovak politicians by. “They were not interested in anything else. When we were thinking most about reform, they had this” (Husák 1997: 229–230). For VPN economists like Filkus, however, Slovakia was vulnerable to an economic “failure of catastrophic dimensions” (Filkus 2006: 63). Slovakia had inherited an unbalanced economy resulting from a Prague-directed division of labor under communism. Slovakia had a less productive agricultural sector and a manufacturing center overly focused on heavy industry, arms production, and unfinished inputs produced for finalization in Czech factories. Factors of production in Slovakia were not nearly as nimble as in the Czech economy. Filkus thus lamented that Klaus’s federal reforms were inappropriate for Slovakia’s specific conditions. A balanced budget would devastate production in Slovakia’s one-industry towns while depriving them of new investment capital. Price liberation would be exploited by unreconstructed local monopolies. Currency devaluation would hurt Slovakia’s raw materials importers while helping Czech finished goods exporters. A new value added tax (VAT) would be collected disproportionately in the Czech lands where finalized products were mostly sold (2006: 63–65). VPN also needed an agreement on the devolution of powers to solidify their centrist position and reputation at home. As Prague resisted and a satisfactory settlement moved increasingly out of reach, unqualified support for reform became increasingly untenable. This was due to the highly competitive nature of Slovak identity politics. Despite wide Slovak agreement on the need for a form of devolution of powers, KDH, the Slovak National Party (SNS), and the communists (soon to be reformed as the Party of the Democratic Left, or SDL’) began to offer increasingly radical solutions to the devolution problem, including outright independence (Žiak 1998). As prime minister, it fell to Me¸ciar to navigate this difficult terrain. He quickly realized that the nationalist attempts to outbid VPN provided him with a resource he could use to win greater economic control and resources from the federal government (Žiak 1998). At home, however, Me¸ciar recast the identity contest as a conflict between the “dangerous nationalism” of opponents like Markuš and his own reasonable Slovak demands. The strat-

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egy worked: local elections in November 1990 produced a sharp rebuke to Slovakia’s most radical nationalists. Me¸ciar now held the center—one built on Slovak demands for more republic-level power and resources.39 Radical Reforms and Slovak Identity Politics

In federal politics, Klaus accused his opponents of communist backsliding that would bar Czechoslovakia’s return to Europe. This appeal echoed the broadly held Czech sentiment that communism was responsible for forty years of stagnation in the Czech Republic. By contrast, Slovaks widely perceived that Czech elites and some Slovak elites were indifferent, or even hostile, to Slovak national interests and economic well-being. Such conditions made Klaus’s federal reform policy politically vulnerable. This national dimension also allowed reform opponents to question the integrity of leading Slovak supporters of radical reforms on identity grounds (Mikloš 1997: 60). The convenient part of the attack was that it was primarily anti-Czech and antifederal, not antireform. It built solidly on foundations sunk by VPN itself in its June 1990 campaign slogan, “A Chance for Slovakia,” and the government program declaration. In both, VPN and KDH deputies professed to be for radical reform, but without pain—implying that such a combination was merely a matter of political choice.40 With the onset of the federal shock therapy program in winter 1991, reform opponents maintained this argument. Shock therapy began before the official January 1, 1991, deadline with Klaus’s surprise decision to devalue the crown against the dollar. Slovak reactions to the devaluation were largely critical. It came too early for Slovak importers. They alleged they would have to wait over two and one-half months before price liberalization would let them raise prices to cover their higher import bills.41 On January 1, 1991, the federal government devalued a second time.42 The bulk of reform measures began on January 1, 1991, with price and trade liberalization and strict new curbs on fiscal expenditures. Slovak government ministers were relatively straightforward in presenting the measures as unavoidable.43 Within several weeks, however, politicians from all parties began to express concern at the severity of the price and credit shocks. Over winter 1991, Me¸ciar publicly maintained a low-profile position on reforms, allowing his colleagues to stake out the most controversial positions. Within the government cabinet, however, he began to discuss a gradualist national alternative that did not correspond with Ku¸cerák’s neoliberalism or the reforms in place.44

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The most outspoken reform opponent in the cabinet was Augustín Marián Húska, Me¸ciar’s minister of privatization. Húska had an Academy of Sciences background in the Institute of Economics and was a strong gradualist with an even stronger Slovak national slant. He was also a leader of the Association of Independent Slovak Economists (NEZES). NEZES was an umbrella organization for a diverse group of nationally oriented economists that had been formed in early 1990 by Hvezdo¸n Ko¸ctúch, “to prepare Slovak steps to economic reforms.” NEZES “looked for a gradual transformation” and in intellectual spirit “was close to Komárek” with whom members allegedly “met to discuss the problem of Slovak transition.”45 NEZES represented gradualism melded with an overriding Slovak national sensibility. The entirely intended implication of the word independent in the name of the organization NEZES was that other economists like Ku¸cerák were directly or indirectly serving some form of non-Slovak interest.46 It thus reflected what VPN activist and sociologist So¸na Szomolányi has argued was the politicized use of identity labels. Nationalist allies were considered “good Slovaks” who recognized “real” Slovak interests while opponents became “bad Slovaks” whose viewpoints willingly or unwittingly played into the hands of the internal and external “enemies” of Slovakia (Szomolányi 1997: 26–28). By recasting their moderate centrist opponents as traitors to the nation in a fight for survival, national-oriented politicians could claim an exclusive right to operate in the political sphere (Gagnon 2004). NEZES was really about the nationalists’ bid for legitimacy and power. Its antireform statements were vague. Nor did NEZES make much mention of what it would do if it had control over reform design. Rather, Húska and NEZES focused on devolution of federal economic power to the republic-level governments. By sticking to general constitutional issues, Húska could win a political victory without having to deal with inconvenient technocratic details. NEZES issued its major statement on reforms in March 1991. First, NEZES asked the Slovak government to “immediately declare the economic sovereignty of the Slovak Republic and above all [declare] sovereignty over decisions about economic reform.” Second, NEZES asked the government to “seek understanding” from “Czech critics implementing reforms . . . of the synergetic meaning of the Slovak economy for the entire Czecho-Slovak economy.” Finally, the organization called for the cooperation of economic experts to “defend” citizens “against the asocial and irritating federal concept of transition to a market economy.”47 Almost simultaneously, junior coalition partner KDH released its own

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Slovak reform alternative. Authored largely by minister of forestry Viliam Oberhauser, the document rewrote the federal scenario along gradualist and state interventionist lines: The federal economic reform scenario does not sufficiently respect the specific formations of the national economy, it concentrates economic instruments dysfunctionally in the federal center, [and] prevents more effective economic processes in the Slovak economy. KDH . . . seeks a socially and ecologically oriented market economy in a sovereign and democratic Slovakia.48

The third line of attack on federal reforms came from Slovak industry. As noted, industrial interests organized early and most coherently around the engineering and heavy industry sectors that had been worst hit by defense ´ udovít industry cutbacks. In May 1990, engineering industry executive L ¸ Cernák and other leading industrial figures organized over 200 Slovak enterprises into the Slovak Federation of Industry. In cooperation with the Czech Federation of Industry they protested the lack of a strong defense conversion and industrial policy at the federal level in tripartite meetings and through direct governmental lobbying.49 In February 1991, the two federations delivered a petition to the federal Assembly demanding “help in solving the difficult economic and financial situation of industrial companies . . . [resulting from] the ill-considered restrictive fiscal, credit, and monetary policy of the federal Government.” Reforms, the industrialists continued, threatened “the collapse of the entire national economy” and a “declining living standard for all citizens of the state.”50 While industry had little success influencing policy directly, given the importance of the national issue in Slovakia, Slovak industrialists were eventually able to find Slovak political patrons, like Me¸ciar, who could.51 This was by no means preordained. Slovakia’s steel sector—located in Košice—was organized at the federal level and was initially more closely aligned with Prague than Bratislava. Indeed, Slavomír Stra¸cár, a former communist steel industry official, helped coordinate the Revolution in Eastern Slovakia and originally called the movement Civic Forum after the Prague movement (Žiak 1998: 136–138).52 VPN’s dissident leadership was disinclined to work closely with industry. This was perhaps a lost opportunity. In a telling anecdote, former VPN official Milan Šútovec recalled that in 1991 he met important industrial officials who had been patiently waiting for almost an hour outside of the office of VPN chair Gál. When he arrived, Gál immediately invited Šútovec in for a long, casual conversation, derisively brushing aside Šútovec’s suggestion that perhaps he ought to meet with the offi-

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cials first. These men, to paraphrase Gál’s remark to Šútovec, “were no longer of any importance.”53 In contrast to Gál, Me¸ciar had a long record of actively courting industrial interests. Under communism he was a state enterprise lawyer. In March 1990, he visited the Soviet Union, allegedly to discuss the prolongation of tank production in Slovakia (Duleba 1997a). In August 1990, he chaired a meeting of industrial leaders that Prague television service characterized as the “first attempt to find a way of putting the Slovak economy back on its feet.”54 With the launch of economic reforms in January, Me¸ciar began to listen sympathetically to industrial concerns and later adopted many of them into his own statements.55 Me¸ciar’s sympathetic ear and antifederal rhetoric thus formed the basis for an alliance of mutual self-interest. The Breakup and Fall of VPN

As Filkus predicted, reforms hit Slovakia harder than in the Czech lands. By March 1991, Ku¸cerák was virtually the only Slovak cabinet member still willing to defend the radical reform status quo.56 He did have a number of allies, however. A range of liberal VPN delegates and supporters including, most importantly, his young protégé Ivan Mikloš, and others joined him in rebutting the NEZES letter in Hospodárske noviny. A group of federally oriented, mostly Czech, economists also responded to NEZES in uncomprehending, impatient, and condescending terms. What the Czech economists misunderstood, however, was most Slovak economists of note, except Ku¸cerák and Mikloš, and almost every single political group, except for the right wing of VPN and the profederal Hungarian minority parties, were calling for greater local input into reform policymaking and implementation. Indeed, by March 1991, the Slovak political center nourished two beliefs that flew in the face of neoliberal policy: (1) that painless reforms were possible, and (2) that Czech and federal insensitivity to Slovak conditions explained the growing pain that was being felt. As the subsequent career of Ku¸cerák would demonstrate, allowing one’s ideological beliefs to venture beyond this national dogma was to expose oneself to a broadside from virtually every political and social interest with a voice on the issue. In March 1991, Me¸ciar and a number of his cabinet members split with VPN’s party leadership. Me¸ciar openly hoped to transform the movement into a nationally oriented party—thus repeating what Klaus was doing in the Czech Republic by carving the ODS out of OF. Officially, his concern related to the poor performance of VPN in recent local elections, where it

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had placed second to KDH. VPN’s local district centers blamed the loss on the poor image and leadership of VPN’s Bratislava-based intellectuals.57 On March 3, 1991, Milan K¸nažko, Me¸ciar’s antifederal minister of international relations, took the lead in splitting the movement with an open challenge to Gál: The fundamental dispute in the VPN movement dwells in the attitude toward sovereign Slovak policy. Prime Minister Me¸ciar supports sovereign Slovak policy. . . . I say openly that influential forces are attempting to make VPN and the Slovak government into a tool of their interests, . . . personalities that stand behind the sovereign character of VPN are being gradually removed and a kind of politburo has been formed in the center of VPN, made up of people who do not have a constitutional responsibility or the mandate of Slovak voters.58

K¸nažko’s statement differentiated a nationalist platform within the VPN. With its nasty implication that VPN leader Gál and the rest of the VPN’s dissident and liberal leadership served the interests of hostile, non-Slovak forces, the speech made the split inevitable. Me¸ciar formally joined K¸nažko, Húska, and others in forming the Platform for a Democratic Slovakia within the VPN movement. The title reemphasized the alleged attempt by Bratislava’s intellectuals and former dissident leadership to rule undemocratically from unelected political positions within the VPN leadership. Me¸ciar insisted that national institutional questions were at the root of the split: “The direction represented by the other side is based more on a Czechoslovak concept rather than that of Slovakia. It gives priority to the position of federal bodies.” Me¸ciar also reiterated the national stand on radical reforms: “Nobody doubts that reform needs to happen; however, reform must be applied to the local Slovak condition . . . by concentrating on the personality of Mr. Ku¸cerák as the only representative of reform in Slovakia . . . communication between economists has disappeared.”59 After some equivocation, Filkus joined Me¸ciar and Húska. Beyond that, the platform split VPN’s government officials and delegates in the Slovak National Council into hostile, warring factions. The situation could not last. With VPN divided, KDH became the largest coherent political movement in parliament, but it could only rule if it went into coalition with one of the ¸ two VPN factions (Malová 1994: 132). While Me¸ciar and Carnogurský had staked out similar national positions, personal animosity between the two leaders—including Me¸ciar’s explicitly hostile statements—bode poorly for such an alliance.60 In late March, KDH threw its support to Gál’s VPN faction in a vote of no confidence in the government. The dismissal of Me¸ciar

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was extraordinarily unpopular and set off protests across the country ¸ (Haughton 2005: 29). Future Me¸ciar rival and industrialist Cernák recalls organizing a pro-Me¸ciar strike among his employees in outrage over the dismissal.61 Had the vote of KDH’s parliamentary delegates had its way, Oberhauser would have been the next prime minister. However, Gál’s VPN ¸ supported the selection of KDH chief Carnogurský to the position of prime minister. Gál’s rump VPN faction—renamed the Civic Democratic Union (ODU)—became a junior coalition partner. Me¸ciar’s faction, Movement for a Democratic Slovakia (HZDS), went into the opposition (Haughton 2005: 29). KDH completed the shakeup by joining opposition parties SNS, SDL, and HZDS in a no-confidence vote for Ku¸cerák. Yet, KDH rejoined the new majority to replace NEZES founder Húska with the outspoken neoliberal and Ku¸cerák protégé Mikloš in the Ministry of Privatization. As the leading party in the ruling coalition with a right-wing junior partner, KDH now became associated with federal reforms and Prague-centrism. This led to severe internal frictions and the final breakaway of Oberhauser’s KDH faction, now named the Slovak Christian Democratic Movement (SKDH), prior to the July 1992 elections (Innes 1997: 429). Me¸ciar was now in a perfect position to capitalize from the rightward drift of KDH: he was extraordinarily popular and could claim to be the victim of an undemocratic coup by VPN and KDH. He could also disassociate himself from any responsibility for the reeling economy, federal reforms— including the recently passed federal privatization program—OF, or any commitment to anticommunism or lustration. Me¸ciar now openly courted industrial managers and former communist apparatchiks (Abraham 1996: 17). More importantly, he no longer had to worry about maintaining both radical reforms and political support. From the opposition Me¸ciar intensified his national critique of government policies uniting a diverse set of interests around a nationally oriented platform that attempted to present alternatives to an increasingly vilified neoliberal status quo. Ku¸cerák took over leadership of ODU. Bereft of the more nationally oriented voices of Filkus, Húska, and especially Me¸ciar, the party drifted further toward a strong profederal and radical neoliberal reform line. As Me¸ciar succeeded in casting VPN-ODU as a quasi-foreign actor on the radical fringes of the political scene with only nominally Slovak political representatives, the party became increasingly isolated. In the political jockeying leading up to the 1992 elections, ODU formed an electoral coalition with the strongly anticommunist Civic Democratic Alliance (ODA). They called for an intensified policy of anticommunist screening for former secret police collaborators in top positions in politics and state enter-

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prises as a means of swiftly eliminating top political rivals (Innes 1997: 420–421). Me¸ciar took a firm public stand against intensified anticommunist politics, gaining him the additional support of anticommunism’s targets: excommunist managers of state-owned industrial enterprises, industrial and state planning bureaucrats, and many of the district-level party chiefs who had followed Me¸ciar from VPN to HZDS. According to Mikloš, communist-era nomenklatura interests, reorganized as the Association of Employers Unions (AZZZ), provided HZDS with significant campaign funding (1997: 64–65).62 Yet given the number of AZZZ members associated with ¸ other parties—particularly, Cernák with SNS, although later with the Democratic Union (DU); Oberhauser, with the KDH-SKDH; and Peter Magvaši with SDL—it seems safe to assume that industry spread its support widely among parties. It also seems safe to assume, however, that the party most closely associated with the federal reform program and lustration, VPNODU, received little, if any, industrial support. The June 1992 elections were a disaster for the coalition parties. VPNODU did not even clear the 5 percent hurdle required to gain representation in parliament. It disappeared as a political movement. KDH also suffered a sharp rebuke with a disappointing 8.9 percent of the vote.63 Me¸ciar’s HZDS received 37.3 percent of the vote and emerged two seats short of a parliamentary majority. Backed by the SNS, it formed the new government (Mesežnikov 1997: 50).

Conclusion

The compromised communist backgrounds of managers, union leaders, and bureaucrats enabled Klaus and T¸riska to design an outsider-friendly federal privatization framework. In Slovakia, by contrast, these groups gained greater political voice through the broader debate over Slovak political identity and corresponding discussion over the appropriate division of resources and powers between the federal- and republic-level governments. As Klaus’s federally designed economic reform policy began to take hold in winter 1991, Slovakia’s insider forces found political patrons willing to defend their interests as part of a broader effort to oust the proreform government. We turn to the politics of privatization in the next chapter.

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5 The Politics of Privatization in the Czech Republic

What is not banned, is permitted. —CZECH LAWYER

Privatization without institutions to enforce good corporate governance may vitiate private property rights and give those with control rights an interest in the persistence of a weak, corrupt state that would not interfere with their theft. —KARLA HOFF AND JOSEPH STIGLITZ, NATIONAL BUREAU OF ECONOMIC RESEARCH WORKING PAPER

rom the final introduction of the Large Scale Privatization Act in February 1991 until the separation of the Czech and Slovak republics on January 1, 1993, the concept and implementation of large-scale privatization in the Czech Republic and Slovakia were, with a few minor differences, largely similar. Following Czechoslovak separation, the Czech privatization framework continued along the original path that had been already set—the Czechs embarked on a second wave of privatization that culminated in 1994–1995. Like the first wave, the second wave had an important, although less aggressively administered, voucher component. In Slovakia, by contrast, a distinct Slovak concept of privatization evolved in a highly contentious political environment. Whereas Czech privatization initially contributed to the political fortunes of Václav Klaus, Czech prime minister, the same program rewarded Slovak prime minister Vladimír Me¸ciar’s political rivals. Changing the popular program, however, was

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enormously controversial and politically difficult. In the end Me¸ciar reoriented Slovakia’s privatization in conjunction with a broader attack on Slovak political institutions. This chapter tells the story of Czech privatization from a political perspective. Czech voucher privatization initially provided benefits to enterprise outsiders. It rewarded citizen voucher holders during the middle stages of economic reform. It also created a new class of economic elite within the capital market and financial sectors—a combination of voucher privatization beneficiaries from a new group of financial intermediary firms and the banks, as well as an assortment of new capital market actors, who hoped to handle trading in corporate shares. The broad distribution of initial benefits of privatization reflected the Czech Republic’s democratic politics. It initially marginalized the highly unpopular ex-communist nomenklatura. Moreover, by enabling broad outsider participation, it built a democratic consensus in favor of privatization and rapid reform. It also served as a political vehicle for its greatest advocate, federal minister of finance turned Czech prime minister Klaus and his Civic Democratic Party (ODS). Nevertheless, the management and results of privatization eroded this consensus as time wore on. The program created property rights before an adequate institutional check was in place. It also concentrated benefits in the state-controlled financial sector. Hence it failed to depoliticize the economy to the extent originally promised by neoliberals. These flaws allowed a range of actors to benefit at the expense of the general public. Many of these actors were postcommunist entrepreneurs with few ties to the old regime, but, over time, the flawed program created some opportunities for nomenklatura insiders to benefit as well. Increasingly, the winners from privatization fell into a smaller circle of enterprise and financial managers, bureaucrats, and politicians, many of whom supported delayed additional change while they reaped the political or economic benefits of partial privatization reforms. A combination of neoliberal ideology and a weak center-left opposition allowed these scams to persist longer than they probably should have, but by 1997 scandals and economic crisis brought down the government and silenced the major opponents of additional postprivatization reform. Democratic politics, in short, put an end to a period of partial reform.

Neoliberal Privatization Concepts

Czech voucher privatization quickly provided private owners for a majority of Czech firms, but, as we shall see, these owners proved to be broadly

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ineffective at transforming enterprises. Part of the problem was the neoliberals’ decision to create ownership before establishing a protective institutional framework to facilitate Coasian contracting. As gradualist economist Lubomír Ml¸coch recalled, Prime Minister Klaus had a “weak sense of institutions,” an ideological predisposition to resist any solutions that might require enhancing the capacity of the state to regulate the economy.1 Citing Friedrich Hayek (1944, 1945), neoliberals argued that they did not have, nor could they reasonably be expected to acquire, the insider, proprietary knowledge required to restructure firms or closely regulate markets (Klaus 1993). Nor could they build adequate capacity to do so, even if they wanted to.2 The Klaus team thus accepted a regulatory environment devoid of burdensome practices, one in which market actors would be able to make decentralized, utility-enhancing decisions in response to competition. Given the choice between creating owners quickly and delaying voucher privatization until proper institutions could be built to govern the protection and transfer of property rights, the Klaus team chose to create owners. Yet, the owners that voucher privatization produced turned out to have uncertain control over the value of their shares. They soon found themselves locked in a fierce, often zero-sum battle to secure control of the more valuable assets of their enterprises. The Klaus team’s response was to allow the first owners to fight it out. “Running ahead of the lawyers,” the Czech Ministry of Finance “turned out the lights” on enterprise transactions. Their fear was that more rigid institutional regulations and enforcement would delay the emergence of concentrated asset holders who could give their enterprises a clear direction. They thus tolerated an often shockingly unfair and vicious process of consolidation over enterprise control.3 As Vladimír Rudlov¸cák, the chief market regulator at the Czech Ministry of Finance, summarized, the voucher program had given Czech citizens and others an opportunity to make some money—but there were no guarantees. If they got hurt, at least they had had a better chance than under a system that had been set up by the industrial managers. Remarked Rudlov¸cák: “We who started this, were always very skeptical. We tried to explain that all of you have the same chances. It’s like a lottery—it’s up to you to decide how you will play the game. Don’t expect we will arrange everything for you.”4 Klaus concurred. As the second wave of voucher privatization was winding up, he wrote: The ambition for transformation privatization was not to be the end of property rights restructuring but, on the contrary, to be its beginning. The

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task of government at that moment was to find the first private owners, not the final ones. This fundamental difference tends to be misunderstood, partly because it reflects the belief in the potency of government intervention and disbelief in the spontaneity of the market. (Klaus 1993)

From the Klaus team’s perspective, ownership consolidation in the new Czech Republic was not supposed to be a fair or particularly nice process.5 But it was supposed to produce ownership structures that enhanced enterprise restructuring and efficiency. As we shall see, this did not turn out to be the case.

State Banks, Investment Funds, and Soft Budgets

Klaus initially intended the Czech voucher giveaway to create an AngloSaxon-style, broad-based shareholding ownership class that would demand disciplined, profit-maximizing managers. Yet they feared that most ownercitizens’ stakes in firms would be so small that they would have little incentive to undertake the cost of serving as an active owner. The result would be a small shareholder collective action problem that would permit enterprise managers to do what they wished with the firms’ assets. Indeed, as we saw in the last chapter, Klaus and Dušan T¸ríska even used this logic to gain managers’ support for the program. T¸ríska realized that the program needed financial intermediaries to help overcome individual shareholders’ collective action problem. He thus created a low barrier for financial intermediaries to enter the market for citizen vouchers. Citizens would simply trade control over their vouchers for shares in the company that ran the privatization fund. Fund managers would invest these vouchers in concentrated blocks of company shares and carry more weight in a corporate general assembly. Intermediaries were expected to be more attentive to managerial behavior than citizens. The entry of intermediaries helped to save the program. As the deadline for voucher registration approached in 1992, a disappointing number of Czechs and Slovaks proved willing to pay the 1,000 K¸cs (1,000 Czech koruna; US$35) administrative fee necessary to get a voucher booklet. This changed, however, when a number of financial intermediaries aggressively began to offer voucher holders a fixed payment of 10,000 K¸cs (US$350) or more in one year in exchange for the right to their investment points. The voucher program quickly went from too few subscribers to too many. At the head of this campaign initially was an unknown company called Harvard Capital and Consulting, an investment privatization company led

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by the controversial twenty-seven-year-old former Harvard University student Viktor Kožený. Kožený’s success at attracting voucher holders to his firm presented the Klaus team with the prospect that new and potentially irresponsible financial intermediaries might gain an enormous ownership stake in the privatized economy through their investment privatization funds (IPFs) (Schwartz 2006: 190–192). According to one disputed report, Klaus’s response was thus to encourage state-controlled financial institutions to set up rival funds.6 Klaus’s deputy minister of finance, Rudlov¸cák, denies this, recalling that the federal Ministry of Finance welcomed Kožený. Klaus even had him come to the ministry for a meeting. As Rudlov¸cák recalls, they were favorably impressed: “We liked him very much; we admired his drive.”7 Whatever the reason, Klaus’s Ministry of Finance allowed state-owned banks to establish financial intermediaries. Given their organizational strengths in the market, the state banks convinced a large number of Czech and Slovak citizens to exchange their voucher booklets for a promise of as much as a tenfold return in a year. The IPFs’ generous offers reflected a well-reasoned and quite rational bet by the investment companies that set up the funds: citizens had acquired their vouchers from the Ministry of Finance for a small administrative fee of 1,000 K¸cs (US$35), yet they estimated that each person’s voucher booklet could command assets worth as much as 30,000 K¸cs (US$1,050). By offering around 10,000 K¸cs (US$350), the intermediaries stood to make a substantial profit (Schwartz 2006: 191). Many players entered the voucher market, but in the end, the bankowned funds performed best. Five bank- and insurance-owned funds—all ultimately answerable to the government through the National Property Fund (FNM) and their ties to the Ministry of Finance and Czech National Bank—took 41.4 percent of voucher points in the first wave and 18.8 percent in the second wave. All told, the six largest investment property funds gained control over 65 percent of the vouchers (Brom and Orenstein 1994; Mertlík 1996; Palda 1997; Schütte 2000). IPFs were limited to a maximum 20 percent stake in firms, and banks could control no more than 10 percent directly. But banks could also write off enterprise debt in exchange for the right to control a block of equity shares. Even where their stake remained low, the dispersion of ownership resulting from the voucher method meant that a 20 percent holding, or even less, was frequently sufficient for a state bank to establish control over a company. As Raj Desai writes, “bank equity ownership of firms, either directly or indirectly, allowed substantial participation in enterprise operations and supervisory boards” (1995: 21).

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This was not necessarily bad. Indeed, T¸ríska’s original intention to create an Anglo-Saxon shareholder economy appeared to have given way to a more German concept of corporate governance in which financial institutions had a major, even controlling, stake in companies that were also their debtors. As Michelle Egan points out, however, the similarity to German modes of governance was in form only (1998). The new ownership system lacked many of the institutions and the culture that kept the German system working. First, the banks remained largely in state hands—answering to the Ministry of Finance and the FNM. Yet in the Czech Republic, state control often blurred or even broke the barrier between legitimate government stewardship and political clients. By combining bank-owned fund votes with FNM votes at corporate general assemblies of shareholders, and through informal arrangements, leading politicians could secure allies on the supervisory boards of a wide range of Czech companies. These appointees were allegedly more active in the governance of strategic politically or economically important firms. To their credit, many of these state representatives would actively work toward enterprise restructuring—often putting significant pressures on managers to restructure their firms (Appel 2004: 64). Yet there are also allegations that state appointees would make sure that the companies did things that the ruling coalition partners wanted, like provide corporate donations to the parties’ campaign chests or delay firing employees in politically sensitive areas during election times. In return, companies could use their political connections to secure loans, gain an advantage in competition for additional privatization deals, seek tax relief and various licensing privileges, and secure other general political needs (Schwartz 2006: 244–245).8 To the extent that the soft credit regime kept unemployment down before the 1996 election, Klaus, the governing coalition parties, and the Czech industrial-sector labor were significant beneficiaries. As Clemens Schütte put it, “It’s an open secret that state representatives at the supervisory boards of the large [state] banks occasionally have exerted pressure on the management to allocate loans according to political rather than economic criteria” (2000: 219). Such rumors abounded and strongly support Schütte’s claim that managers were aware that the government did not want to risk a chain of insolvency before the 1996 elections. As Schütte noted, full employment trumped a harder financial constraint on firms (2000: 236; see also Egan 1998; Korinek 1994; Stark and Bruszt 1998: 153–164). Banks also used enterprise control to solve their own problems—often at the expense of the enterprises. As bank officials feared that restructuring enterprises would lead to “large-scale bankruptcies and massive loan write-

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offs,” banks often supported inefficient firms in their portfolios “with easy loans, refusing to cut off the flow of cash or force these firms to restructure” (Egan 1998; see also Brom and Orenstein 1994; Desai 1995; Stiglitz 1997). Meanwhile, the government failed to implement an effective bankruptcy framework. As a result, creditors had to wait for months and even years for a court date, and debtors were left with many means by which to win a stay of execution. This was intentional. While nominally in favor of a strong bankruptcy framework, Klaus and his minister of finance, Ivan Ko¸cárník, feared that bankruptcy could undermine privatization. Who would want to bid on a firm that was about to be auctioned off in parts with the receipts going to creditors? Ko¸cárník thus promised firms in the privatization process immunity from bankruptcy proceedings until six months after they were privatized.9 In addition, bankruptcy was reserved only for firms in “primary insolvency,” meaning that only firms that could not sell their goods were eligible. In addition to these restrictions, it took the Czech government until April 1993 to pass the law, but even after that the bankruptcy courts remained understaffed and neglected by government policy (Desai 1995: 19). This was a temporary godsend to heavily indebted and insolvent industrial enterprises. Many enterprises lost their markets in the East due to the collapse of the Council for Mutual Economic Assistance (CMEA) and the inability of former Soviet bloc partners to pay foreign currency for their imports. In addition, the West was in the midst of a recession triggered by the high cost of German reunification. On top of this, managers had to contend with an ongoing program of macroeconomic stabilization, which reduced state subsidies, raised the cost of credit, reduced domestic demand, and led to higher input prices. Had they been subjected to the discipline of hard credits including a rigorous bankruptcy framework, there was the risk of chain bankruptcies as the liquidation of suppliers or buyers pushed solvent firms into illiquidity and possibly insolvency. Managers, initially squeezed between hard budget constraints and failing markets, were allowed to relax (Schütte 2000: 220–227). Free from bankruptcy fears, enterprise managers increasingly made ends meet by ceasing payments to their suppliers, allowing their external debts to grow in the form of accounts payable, while themselves taking on increasing volumes of uncollected receivables. By the end of 1993, interenterprise debt totaled about one-third of Czechoslovak GDP (Desai 1995: 27). Banks also engaged in debt loading captive firms. Debt loading is the practice of pushing unnecessary loans on firms at high rates as a means of extracting funds from cash-rich companies. According to Andrew Schwartz, it was a common practice among bank-owned IPFs. Since debt loading si-

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phoned off cash that should have been shared with the enterprise ownership’s minority shareholders, it was a form of tunneling (Schwartz 2006: 236–237; see also Appel 2004: 64; Fidrmuc and Wörgötter 1998). While the government may not have used its influence over the four largest banks to enforce this, neither did it take steps as primary owner to ensure the banks behaved themselves (Desai 1995; Svejnar 2002).10 One partial solution to these conflicts of interest might have been for the government to find more effective owners for the state financial institutions. As a neoliberal, Klaus must have been aware that as long as he failed to depoliticize the banks, the broader neoliberal quest to depoliticize the economy was doomed to fail. But the government proved unable to fully privatize the banks. Some of the problem was political will; given the degree to which the state sought to ensure control over bank management, it appears likely that many officials were reluctant to lose the ability to shape political and economic outcomes through the manipulation of credit. Yet the problem was also that the increasingly dismal Czech loan portfolios depressed foreign investor interest in buying into the banks. In 1994, the percentage of nonperforming loans in the Czech Republic peaked at 38 percent! This dropped by the end of 1996, but even so, the rate of nonperforming loans among the four largest state-owned financial institutions ranged from 19 to 26 percent. Even with government guarantees, only one of the four had adequate reserves to meet their nonperforming obligations (Schütte 2000: 219). In 1995, these banks housed 85 percent of all deposits (Desai 1995: 23). Nor did potential buyers wish to face the political heat that genuine restructuring of firms in bank portfolios would incur. Hilary Appel relates how the Klaus team had difficulty finding buyers for one state bank despite discounting shares by as much as 50 percent (2004: 63).11 In sum, five years after the fall of communism, many enterprises in bank fund portfolios remained as dependent on soft loans as they had been on soft subsidies under communism. The form of finance had changed, but most large and medium-size firms still enjoyed a soft budget constraint that allowed them to delay the hard realities of markets. There was some speculation that state bank ownership might have provided a soft landing for the Czech transition by floating inefficient Czech firms long enough to allow a more efficient Czech private entrepreneurial sector to prepare the way to take up the slack during their eventual and inevitable restructuring or liquidation. The reality, however, appears to have been that a combination of politicized soft lending and bank-enforced debt

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loading raised interest rates for financially sound enterprises; this, in turn, reduced investment and slowed the growth of the efficient private sector (Palda 1997: 92–93). Not surprisingly, the years 1994–1997 were characterized by high levels of interenterprise and enterprise debt, a rise of uncollectable assets on bank and firm balance sheets, and slowly mounting macroeconomic imbalance.

The Rise and Demise of Czech Equity Markets

While easy enterprise credit was a large problem, the Klaus administration’s unwillingness to regulate the new capital market had equally devastating effects. Created in 1993 to handle the trade in corporate shares, the Prague Stock Exchange soon developed into a nightmare for minority shareholders. Again, this was at least partially intentional: a by-product of the neoliberals’ desire for firms to transfer as quickly as possible from dispersed first owners who lacked the incentives and ability to discipline management, to secure owners in command of their assets. First, the Ministry of Finance found ownership limits on the intermediaries both difficult to monitor and enforce. Weak reporting requirements, high share dispersion, and off-market trades in material shares often kept the real owners of firms hidden from the public and other shareholders (Schütte 2000: 124). Additional mystery could be achieved through informal ties with other shareholders, or shares in daughter or parent firms. This often allowed investment privatization companies, and others, to gain control of a much larger stake in firms than was formally permitted.12 The opacity of the market in shares was dangerous for minority shareholders, who were often the last to know who really controlled a firm. In a common worst-case scenario, a particularly unscrupulous investment company would quietly gain majority control of an enterprise or an IPF, shift the assets to a new legal entity in exchange for some worthless asset, and leave the minority shareholders owning an empty shell. But this is just one example. Schwartz has identified fifteen tunneling techniques, many described in this book (2006: 241–244). Within two years, such practices had virtually driven speculative foreign and domestic portfolio capital from the market while robbing many unwary individual voucher investors of their initial gains. Sadly, tunneling and asset stripping were exactly the sorts of market behaviors Klaus’s team in the Ministry of Finance might have expected had they thought it through. Neoliberals were among the first to stress the need

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to create institutions promoting good corporate governance structures that would respect shareholder value and hold managers accountable for corporate performance (Boycko, Shleifer, and Vishny 1995). Yet, the neoliberal emphasis on creating private property before institutional frameworks left owners and managers alike with many paths to extracting value from a firm short of actually restructuring it. Under Klaus’s regulation-light conception of capital markets, creditors and minority shareholders received no share of the productive assets that were carved out or siphoned off. Worse, the quasi-legality of tunneling and high levels of public loathing—many voucher holders, referred to as small-change shareholders, were, after all, among the primary victims—forced the primary culprits to take their liquid assets abroad or to launder them through purchases of luxury items that were often imported from abroad. Unfortunately, many siphoned assets were thus consumed on nonproductive luxury goods or driven from the country. The Ministry of Finance was unwilling and later incapable of stopping the stripping and tunneling that occurred on its watch. Indeed, often they did not see it as illegal (Schütte 2000: 269; Schwartz 2006: 241–244). The Ministry of Finance’s capital-markets regulation team under Rudlov¸cák saw the primary purpose of the capital market largely as a forum for concentrating ownership—by fair means or foul as long as they did not blatantly transgress the law. To their credit, they did go after a number of cases of fraud. Yet, with only thirty staff and virtually no financial expertise among the police— a perhaps inevitable result of the Klaus team’s mindset—Rudlov¸cák felt they had been too understaffed to undertake their monitoring mission.13 Most funds appeared guilty of some form of tunneling. As the World Bank’s Joseph Stiglitz noted, the discounts attributed to management of Czech funds were “by far the largest in the world. . . . What is remarkable about the Czech funds is that managers are seen as taking away 40 percent to 80 percent of value. Such subtractions from value are clear market statements concerning . . . tunneling. . . . No other convincing explanation of discounts of these magnitudes could be presented by anyone” (1997). In addition, Stiglitz pointed out a new phenomenon. The Czech Ministry of Finance had been quietly encouraging greater concentration of ownership in the hope that clear owners would enhance enterprise efficiency. Yet in contrast to Western experience, there were “huge decreases in market value when an individual achieve[d] market control.” Theory predicts, Stiglitz argued, that the emergence of a dominant shareholder should have guaranteed that someone was there “monitoring and ensuring good performance.” In most markets, this would invariably lead to an increase of

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share value. Yet in Czech markets, it had exactly the opposite effect—particularly when the emergent owners were funds (Stiglitz 1997; see also Appel 2004: 65; Weiss and Nikitin 1998). The most likely explanation, Stiglitz argued, was that when a fund or a firm was taken over, minority shareholders could no longer be sure that their shares would be of any value and would try to sell the shares before the new owners could strip the company or fund of its assets. As the Czech stock market was notoriously illiquid, one might fail to find a buyer at any price. In addition, dominant shareholders had an incentive to keep things this way; when share prices tumbled, they could consolidate control of their firm at a share price that was only a fraction of the company’s actual net asset value (Stiglitz 1997). While bank-owned funds had lower discounts than nonbank funds, they were still large. Given arrests of officials in the banking community in early 1997 for various forms of fraud, Stiglitz concluded that banks also engaged in various forms of asset diversion at minority shareholder expense (1997).14 While some argued that the actual value of assets tunneled from IPFs was quite low as a portion of GDP, Schwartz makes a convincing case that the damage to the economy was much greater (2006: 254–255). Despite initially heavy foreign portfolio investment in the capital markets, foreign capital soon dried up as investors came to realize the dangers of investing in a predatory and underregulated market with virtually no guarantees of protection for minority shareholders and a corresponding inability to find buyers for minority stakes in companies at virtually any price. Except for investments in a few blue chip companies that approximated Western levels of transparency, nobody without insider knowledge invested to earn dividends or seek capital gains. Nobody launched an initial public offering (IPO) to raise capital. The control and market liquidity issues made that too risky. Rather, cash-strapped firms borrowed money at rates made higher by (1) alleged bribe demands for as much as 10 percent of the loan; (2) politicized lending to firms tied to party contributors; (3) the dominance of “too big to fail” enterprises in the credit markets; and (4) the ability of firms owned by bank funds to get loans regardless of their ability to repay. Borrowing from foreign banks was cheaper for creditworthy firms, although given the growing exchange risk, this remained an option only for exporters. Large utilities and manufacturing firms instead issued bonds that over time became the major center of activity for the market (Schwartz 2006: 249–250). The primary practical purpose of the Czech capital market, therefore, was to provide a forum for the rationalization of the ownership patterns resulting from the popular, but untidy, process of privatization. To Rudlov¸cák

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and Klaus, the need to create second sets of owners in clear and secure control of their firms apparently justified the damage done to minority first shareholders. Nevertheless, even second owners frequently remained incapable of bringing sufficient managerial talent and new capital to bear on firm restructuring. They often remained more concerned with maximizing their short-term benefits through overborrowing, insider trading, tunneling, and asset stripping rather than restructuring firms. For the better part of the four years following privatization, a significant portion of voucher privatized firms languished (Schwartz 2006: 255–257).15 Insiders Make a Bid for Policy Control

With the start of privatization, Klaus and other political leaders welcomed industrial managers into their fold as long as they brought financial support and did not criticize his overall conception of reforms. By 1993, however, nomenklatura industrialists made a serious bid to gain greater direct control over the property transformation framework. Similar to Slovakia, they fused ¸ their efforts with a nationalist appeal. The Ceská cesta (Czech way) of privatization was an effort by Czech industrial insiders to reduce foreign and domestic fund participation in the privatization of state-owned companies to a secondary, portfolio role. Czech managers would privatize strategic Czech companies on generous terms. Capital for modernization would come from state-controlled financial institutions that would be coordinated through party-state-industry ties. Where foreign marketing networks or technology was essential, they could be purchased outright using Czech capital or through subsidiary joint ventures with a maximum of 49 percent foreign participation. The primary targets of the Czech managers were the most important unprivatized sectors of Czech society—most notably transportation, energy, and telecommunications. ¸ The Ceská cesta was thus a clear bid to undo the new balance of financial and economic power. Not surprisingly, financial sector managers and many market actors from the privatization companies opposed it. These groups had support scattered across the ruling coalition, but most notably found support among strong anticommunists like Ján Ruml, minister of the interior and a member of ODS. While Klaus had used the politics of anticommunism in the past, it had been largely to stifle resistance to his radical reform program. But Klaus was also interested in party building. Wherever former communists fell in line with his goals, he showed little interest in delving too deeply into backgrounds. The debate over the Czech way was thus caught up in the murky politics of clientelism with Klaus, the prime minister, and Vladimír Dlouhý,

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minister of industry, ready to compromise with important industrial managers. Ruml, however, received strong backing from the new financial and market sector actors, who appreciated the way his sharp, uncompromising anticommunism could be used to protect the voucher program from an industrialist backlash. He thus limited Klaus’s flexibility to tread the fine line between anticommunism and patron-client relations with former communist managers. The Chemapol Case

The debate over the Czech way reached its climax in relation to the privatization of the Kau¸cuk and Kralupy oil refineries from 1993 to 1995.16 These negotiations put a group of Czech industrialists with ties to the past communist regime in competition with a consortium of Western companies with the uninspiring name International Oil Companies (IOC).17 The IOC sought to take a 49 percent stake in the refineries. In exchange they would invest heavily in the modernization of the refineries and finance the building of a crude-oil pipeline from Ingolstadt, Germany, to lessen Czech dependence on Russian supplies.18 In May 1994 the Czech cabinet’s Economic Council suddenly and quite unexpectedly expressed a preference for an all-Czech deal involving Czech industrial managers and Czech banks. The primary beneficiary of the reversal was expected to be the large holding company Chemapol, led by Václav Junek. Chemapol had been established at the start of the communist era as the monopoly trade company for pharmaceuticals and petroleum products. During the economic experimentation of 1967–1968, it was one of the few companies converted into a joint stock company, and its shares were distributed among the country’s chemical producers. During normalization, it became the private reserve of the petrochemical industrial nomenklatura. To facilitate its role as a foreign trade organization, Chemapol established subsidiaries elsewhere in the socialist world and its employees developed strong, personal relationships in the former Soviet Union and China. At the time of the Velvet Revolution, Chemapol’s primary source of revenue came from imports of Russian crude oil. Just after the Revolution, Chemapol’s owners in the state-owned chemical industry spontaneously converted Chemapol to an independent holding company. This removed it a step further from the industrial ministries now controlled by Civic Forum (OF) and Public Against Violence (VPN). It also put its managers out of reach of the lustration law that only applied to state-owned companies in which the state or the FNM had a greater than 50 percent share.19 Chemapol could thus

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continue to serve as a safe haven for the interests of communist-era industrial managers. Chemapol’s owners in the Czech chemical and petroleum industries also had a strategic vision. The end of communism had led to the atomization of the industry’s highly integrated, vertical production process. As crucial parts of the chain were carved out and either sold or put into the service of foreign producers, other units within the old production chain suffered. Chemapol was a well-heeled, independent entity out of reach of neoliberals in government and thus became a natural focal point for industry efforts to reestablish secure vertical integration. With the collaboration of a tightly connected network of industrial executives, Chemapol launched an aggressive industrial acquisition program within the petrochemical industry. Acquiring the lucrative refineries was a natural step in placing this recombinant network on solid footing.20 Not surprisingly, the Economic Council’s May 1994 decision to back Chemapol and the Czech way in the privatization of the oil refineries sent shock waves through the governing coalition. To former dissidents, anticommunists, and others within the government, Chemapol must have represented the heart of unrepentant communist profiteering from the Revolution. Despite Klaus and Dlouhý’s preference for the Czech managers, in spring 1994 Ruml’s Ministry of the Interior hinted that the May decision was linked to KGB influence and to officials with ties to the former communist secret police.21 This claim was strengthened when Ruml subsequently announced that certain unnamed top managers of the petrochemical holding company Chemapol had been in a section of the former communist secret police under direct KGB influence. The release added that Chemapol, as an oil trading company, had ties to the Russian mafia and might be a means for Russia to prevent the Czech Republic from completing the associated German pipeline project (Šubert 1994). Ruml also hinted that Dlouhý, minister of industry and trade—who was, perhaps, the strongest government proponent of the Czech way—might be serving as an agent of Chemapol or even Russia.22 Klaus initially ignored the charges and then subsequently said he would refuse to look at the documentation, as did a number of other ministers.23 In early August, the Communist Party of Bohemia and Moravia, the Czech Republic’s unrepentant Bolshevik fringe party, came out publicly in favor of Junek and Chemapol.24 Amid the furor, Klaus called for a rethinking of the Czech way of restructuring the petrochemical industries. Dlouhý followed suit, and by fall 1994 the Ministry issued a statement detailing why foreign participation was essential (Sabela 1994). The government then

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reopened talks with the IOC, effectively squeezing out Chemapol. The IOC received a 49 percent stake in the refineries, with 51 percent going to a newly created petrochemical holding company called Unipetrol. Chemapol quietly assumed an 8 percent share in Unipetrol (ING Barings 1997: 13–15). The IOC’s participation in the final deal helps illustrate the continuing importance of anticommunism in Czech privatization. Similar to the use of nationalism in Slovakia, it served as a nonmaterial resource that an important constituency used to justify control over the process (Appel and Gould 2000). From the start, the politics of anticommunism put Czech industrial managers on the defensive and weakened their capacity for collective action. To gain access, Czech industrial managers had to approach the parties of power as clients, not as independent and important collective social actors. While many enriched themselves through personal contacts and clientalist arrangements, as a whole, the ability of managers as a social interest group to shape policy remained low.25

Dislodging the Winners

Much of the conflict over Czech partial reforms occurred within a narrow circle of economic and bureaucratic actors with a variety of ties to the ruling coalition. There were two broad-ranging and interrelated debates: (1) what to do about the capital market, and (2) what to do about financial sector privatization and conflicts of interest. The divide between partial reform winners and partial reform losers could be loosely reduced to material interests. The most coherent group of partial reform losers came from an increasingly vocal lobby consisting of net creditors and actors whose livelihood was connected to portfolio positions in firms and funds. This included capital market funds concentrating in portfolio investments, brokerage houses, and foreign and some domestic banks. In general, they sought to protect the value of their portfolio and net credit positions in the Czech economy. But many also sought additional reform as a way of attracting additional foreign investment and enhancing economic efficiency by enforcing mechanisms that would ensure that assets flowed relatively quickly to where they would bring the greatest rate of return.26 The goal of this group of partial reform losers was to give the market greater transparency and to extend minority shareholder protection. They also tended to favor quick bank privatization with foreign participation and supported steps to eliminate conflicts of interest between banks and bank funds. They emphasized the need for a strong, regulatory Securities Exchange Commission, guarantees of minority shareholder rights, and other

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steps to create a more regular capital market. Tomáš Ježek, an ODS member and president of the Prague Stock Exchange, best represented most of these reforms. Ježek’s group had a number of political liabilities. Minority shareholders had little voice in the management of firms and thus may have lacked the ability to make enterprise cash, or services, available to leading political parties and, most ironically, to Ježek’s own ODS. In addition, enforcing creditor rights would entail the restructuring and dismantling of firms, leading to unemployment and disgruntled managers and majority owners. On political grounds alone, Klaus had a strong short-term incentive to ignore the Ježek group’s demands.27 Yet, even if such political interests had no role in winning over Klaus, the prime minister could find justifications for ignoring the demands of partial reform losers in his own neoliberal ideology that lauded the unregulated spontaneous market. The primary spokesperson for this argument—and thus for partial reform winners—was the architect of voucher privatization, T¸ríska. The argument against greater regulation was that it would slow consolidation of shareholding. Rudlov¸cák and T¸ríska argued that if the government required majority shareholders to offer to buy out minority shareholders, trading and the consolidation of ownership would stop. They saw an unregulated market, with all its unfair side effects, as crucial to the continued emergence of capitalists. If there was to be reform, Rudlov¸cák felt that it should be based on the creation of a new, regulated market, consisting of the twenty or so listed companies that regularly paid dividends and met Western levels of transparency. This market would exist alongside what critics called the “wild” system. As firms got their financial house in order, they could go to the new formal market where they could launch IPOs, have their shares traded on a liquid secondary market, and offer dividends to better-protected portfolio shareholders.28 This arrangement, however, would leave minority shareholders of most Czech companies unprotected. With no way to sell their shares in an illiquid market, they had little alternative but to watch as the value of their property was simply stripped away by the controlling owners. After 1993, T¸ríska was the head of RMS Systems, the company that controlled the computerized trading of the nonpaper shares that had been made necessary by the overnight creation of millions of shareholders. T¸ríska remained a close Klaus associate and enjoyed his support. T¸ríska could also count on at least the tacit support of a range of funds and enterprise controlling shareowners. These had allegedly quietly benefited from insider deals and tunneling. They sought to preserve the unregulated character of

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the market as a means of expanding their holdings without having to compensate minority shareholders for their share of the asset value of the firm.29 Ironically, once reviled by the neoliberals, many industrial enterprise managers of domestic firms had now come into loose agreement with their policies. Their firms tended to be indebted and they enjoyed the Klaus era’s soft budget constraint. They thus continued to resist the privatization of banks and the strengthening of the bankruptcy enforcement. They, too, sought to use the unregulated character of the stock market to consolidate control over complex networks of enterprise bank and fund assets. These allowed them to socialize debt internally and pool investments to modernize and internally secure suppliers and markets.30 These arguments played themselves out in the financial press among a small circle of market, bureaucratic, industrial, and parliamentary actors. ¸ The political opposition, led by the Social Democrats (CSSD), and reformers like Ježek from within the ranks of ODS and its partners, began to launch a wide range of critiques of the Klaus-style transition. Critics made a range of demands, from calls for rapid bank privatization and market regulation by Klaus’s coalition partners and politicians within his own party to demands by academic opposition from the center left for renationalization of enterprises and a gradual state-administered reprivatization (Ml¸coch 1997b: 8–9). These voices of dissent, combined with public dismay over privatization-related government and market scandals and the beginnings of an economic slowdown, generated a particularly weak showing for Klaus’s ODS in the June election of 1996. The late spring election left Klaus’s coalition two seats short of a majority in the Czech National Council and forced it to ¸ form a minority government in the face of a resurgent CSSD. One of the remarkable things about the Czech reform debate of 1996– 1997 was the degree to which the winners of the privatization process, and coalition government supporters in particular, honestly believed that nothing was wrong right up until the economy was already in sharp decline. In polls in 1994 and 1996, for example, four-fifths of the Czech Republic’s top economic elites expressed satisfaction with the direction of change in Czech society. This was almost assuredly facilitated by Klaus’s continued rhetoric of economic success and radical reform. Indeed, Klaus seemed to have lulled his own party into a stupor of complacency and what critics called “stubbornly non-adaptive policies” that increasingly weakened the party’s broader support at the polls (Machonin and Turek 2000: 41–42). By 1995, it was becoming clear that the system of ownership and government oversight that had emerged was harming the Czech Republic’s postcommunist economic recovery. The decline began in 1994 when the

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Czech National Bank had to take over two small banks after the controlling owners wrote themselves too many loans (Desai 1995: 24). A year later, Motoinvest, a superaggressive, leveraged buyout firm, used its control over two larger banks to fund acquisitions. In the process it hollowed out one bank and seriously crippled a second. In 1996, authorities had to assume over $450 million in depositor obligations. To cover the bill, the government sold a controlling share of the state-owned insurance company to another private firm with close ties to Minister of Finance Ivan Ko¸cárník (Orenstein 2001: 89–90). By 1996, the proportion of elites happy with the direction of change dropped significantly, as over half indicated that they would like to see additional radical reform measures (Machonin and Turek 2000: 42). Increasingly, privatization winners—the mainstay of support for Klaus’s reform policies—argued among themselves over what to do next. Meanwhile, among the broad public the perception that Klaus was out of touch with what was going on produced a steady shift in voter allegiance leftward to the ¸ rival CSSD led by ’68er Miloš Zeman. Investors’ fear that the Czech miracle was built on unsustainable debt made it vulnerable to the general financial panic that followed the collapse of Asian real estate and financial markets. A run on the Czech crown and a ¸ sharp devaluation in spring 1997 led the CSSD to attempt a vote of no confidence in the governing coalition. Klaus won, but only by a single vote, a vote he got only after publicly committing himself to submit his future bank privatization plans to parliament for discussion and a vote, rather than to go through administrative measures controlled by the coalition’s bureaucrats. Klaus also fired his leading capital markets regulator, Rudlov¸cák, following a scandal over a blatant laxity by the Ministry of Finance. In early 1997, Rudlov¸cák’s office approved a capital transfer abroad of US$46 million in assets from an IPF called CS Fondy—effectively cheating over 45,000 investors of their assets. One month earlier, a similar scandal had hit the Trend Investment Fund. Again, the Ministry of Finance regulators had apparently done little to stop it. The funds’ minority owners were left with virtually nothing.31 While the Trend and CS Fondy cases were extreme in that the controlling owners took all they could get in a single transaction, by mid-1997 it was increasingly clear that some form of tunneling or asset stripping was common practice in most ownership arrangements (Stiglitz 1997). Rudlov¸cák’s dismissal indicated a shift in market regulations in favor of the Ježek camp within ODS. Indeed, by the following year, Ježek ally Jan Müller had a parliamentary go-ahead to set up a Securities Exchange Com-

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mission.32 The coup de grace to the Klaus era’s blind eye to partial reform rents came after an ODS financing scandal in November 1997. The allegations seemed to confirm what most people had suspected: that coalition parties had been funding their activities through privatization favors to politically connected entrepreneurs (Orenstein 2001: 90–92). The scandal led to the resignation of the Klaus government on December 17, 1997. Czech National Bank president Josef Tošovský replaced Klaus as the head of an interim government pending new elections. Led by Ivan Filip, Ko¸cárník’s replacement as minister of finance, the Tošovský government undertook a number of steps toward market regulation and an eventual solution to the bank mess. His steps met with little resistance from any part of economic society and seemed to produce a collective sigh of relief. In the jockeying for the 1998 election, all parties cautiously positioned themselves in favor of more reform. Ruml and a range of centrist ODS deputies split to form a new party, Freedom Union, where they distinguished themselves from the rump ODS by calling for greater capital markets regulation. Under intensely competitive political conditions and facing general anger among voters, the winners from the Klaus era’s partial reform regime ¸ remained silent. The CSSD made capital market regulation a key part of their campaign. After doing well enough in the June election to form a government, they embarked on a “legislative hurricane” that essentially changed the incentive structure in the markets. Increasingly deprived of the ability to win partial reform rents through politicized borrowing, tunneling, or asset stripping, many postprivatization entrepreneurs simply cashed in—generally by selling their assets to foreigners. Others tried to make up for increasingly hard budget constraints by putting their cash into their lossmaking enterprises (Schwartz 2006: 270–284).

Conclusion

The development and defense of the Czech Republic’s short-lived, partial reform equilibrium caused the country considerable economic damage in the mid- to late 1990s. In hindsight, Czech privatization’s damaging aftermath originated from inherent flaws in the design of the Czech privatization process that were then magnified by Klaus’s unique combination of neoliberal anti-institutionalism, often self-defeating political realism, and the opportunistic actions of well-placed market actors to maximize their interests under a regime of partial reforms. If anything positive can be gleaned from the Czech experience, it’s that Klaus’s broadly distributive, outsider privatization framework and its af-

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termath threatened the consolidation of liberal political institutions only at the margins. These institutions in turn allowed society to identify—albeit belatedly—what ailed it and pressure their political elites to address the problems. The deeply unpopular postcommunist left had been rightly marginalized from the start—and, under competitive democratic conditions, failed in their efforts to create a Czech way of privatization that would put them back in control of the architecture of the process. With insiders sidelined, the main battles thus occurred within the winning coalition and underneath the umbrella of the dominant party, ODS. In contrast to Slovakia, where the insiders prevailed in seizing control over the design of the privatization framework, privatization conflict in the Czech Republic never spilled over into a serious attack on democratic political institutions. The strength of the postcommunist center right meant that the patrons and beneficiaries of policy mistakes remained unchallenged for longer than if the postcommunist left had been more politically viable (Grzymala-Busse 2002a; Orenstein 2001). Yet, the end result was that the Czech privatization framework’s effect on democratization was essentially benign. First, there was a democratic consensus supporting the broad outlines of the privatization program. Voucher privatization in the Czech Republic reduced the intensity of distributional conflict by initially attempting to reward almost everyone. Industrial managers inadvertently gained some insider advantages, but foreigners, new financial actors, and, most importantly, average citizens also played an important role. In this sense, privatization speeded—or at least did not impede—the transformation to a more liberal democracy. It reaffirmed the displacement of old communist elites from what Lenin once called “the commanding heights” of the political economy (Yergin and Stanislaw 1998). Yet privatization by no means depoliticized the management of the economy. Rather it transferred political control from the old industrial branch ministries that dominated economic activity on the eve of the Revolution to the federal and later Czech ministries of finance where Klaus had greater control. Second, it was also crucial that the broad distribution process created rival and crosscutting interest groups that fought for control over economic policy. While partial reform winners maintained the upper hand, they never consolidated around any single set of social or political interests. Rather they were frequently only loosely aligned politically or divided among themselves. It is important to note that the main figures in the capital markets regulation debate (Klaus, Ko¸cárník, and T¸riska vs. Ježek and Filip) were all ODS associates. The debate may have similarly divided collation partners (ODA, CDU), fund managers, bankers, and industrial managers. Hence, the Czech Republic’s slow and confused progress toward eliminat-

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ing privatization’s partial reforms had an important upside. The Czech Republic’s partial reform winners and losers did not fall into recognizable political or social cleavages. This, as we shall see, was different from Slovakia, where partial reform winners organized around a largely ex-communist popular-nationalist left. In addition, even as partial reform winners continued to gain from partial reforms, they only did so marginally. Over the final two years of the Klaus government, it became increasingly unclear whether the gains outweighed the losses. Indeed, winners may have wished to hold on to their rent-winning positions, but the alternatives offered by the challengers were not that drastic and might have even profited them in the long run. Nor was there ever a politically feasible threat to reverse privatization—only to reform capital markets and the financial system (although see Ml¸coch 1997b). Thus, overall, the preferences were lightly held. This, too, had a soothing effect on political competition. The one place where privatization had truly malign institutional effects was in the area of the rule of law. Under the Klaus regime, it underwent significant stagnation in association with the privatization process and its aftermath. The ruling coalition’s apparent indifference to minority shareholder rights may have speeded the consolidation of a second wave of owners, but it also resulted in a long litany of unethical or illegal corporate tricks. The ruling coalition appears to have traded privatization favors, funneled loans to the politically connected or regionally important, and permitted—whether through indifference or incompetence—market-related corruption associated with ownership concentration. This damaged domestic and international confidence in markets, increased the number of channels for rent-seeking, and retarded the development of a more liberal political and economic culture. Ironically, however, corruption in the Czech Republic seems to have been an equal opportunity activity. Most of the parties with access to channels of decisionmaking in the political economy, including the Christian Democrats (CDU); the Civic Democratic Alliance (ODA); and, following ¸ their great boost in the 1996–1998 elections, CSSD, appear to have competed with the ODS in engaging in some form of client network building. While it is a sobering thought, this equal opportunity cheating might have lowered the stakes of political competition. The counterfactual example also happens to be quite similar to the Slovak case, where the ruling coalition systematically raised political stakes by seeking to eliminate its opponents’ access to all channels of political and economic decisionmaking.

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6 The Politics of Privatization in Slovakia

Just privatization does not exist; we all know that the only criterion was loyalty. —VIT’ÁZOSLAV MORÍC, SLOVAK NATIONAL PARTY HONORARY CHAIR

heory predicts that political and economic insiders will be more likely to control a postcommunist privatization framework as a nation’s democratic institutions decline in quality. Privatization to insiders under illiberal political conditions produces independent economic agents, but there is no guarantee that those agents will then agitate for the depoliticization of the economy, the rule of law, or greater political accountability. Indeed, it is just as likely that they will use their insider influence to secure policies that guarantee themselves a profit—often at public expense. This is not necessarily a condemnation of insiders. “People respond to incentives,” to quote William Easterly (2001); where outsiders can get rich through unethical behavior, they often do so. Indeed, many of the villains of the previous chapter were new actors in the Czech economy. The real culprit in cases of prolonged self-dealing is the lack of a hard democratic constraint that can force politicians to safeguard against economic self-dealing (Orenstein 1996b). The Czech Republic had this, but thanks to the weakness of the new left, it took a while to assert itself (Grzymala-Busse 2002a). In the meantime, neoliberal ideology made a virtue, which was perhaps necessary, of the lack of state capacity to safeguard minority shareholder property rights, enforce debtor contracts, and protect the right to transfer assets

T

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to others voluntarily. Neoliberals hoped that the resulting lawless environment would speed the creation of second owners, who would then demand that the state begin to provide these public goods. But with the state both indifferent and blind to what was going on, insiders and outsiders expropriated value from others. There were political limits to this theft, however. The Czech Republic’s relatively competitive politics and watchful society soon helped limit the unethical profiteering—even if poorly at first. By 1997, politicians felt compelled to police the country’s wild west economy. Such political limits did not emerge in postcommunist Europe’s illiberal-pattern states. We will see in Chapter 7 how postcommunist insiders in Ukraine used their asymmetric access to political power to benefit from their positional proximity to state assets. Outsiders could gain access only where the state was weak or through ad hoc deals with the position holders. The system appeared locked in place by illiberal politics—an enduring partial reform equilibrium. Only a mass movement after the fraudulent 2004 presidential election offered Ukrainians an opportunity to hold elites accountable for their self-dealing. Slovakia, the focus of this chapter, is an in-between case. As in the Czech Republic, former Communist Party bureaucrats and industrial managers were on the defensive after the Velvet Revolution. But by fusing their interests to rising popular-nationalism they soon gained the influence they lacked in the early days of the postcommunist period. This was a particularly nasty turn. As self-proclaimed founders of the nation-state, popular-nationalist leaders used polarizing identity rhetoric about a nation under threat from external and internal enemies to justify seizing control over the major economic assets of the state. One of their main economic goals was to stop the highly popular mass voucher privatization program they had inherited from the federal republic. This had little to do with the voucher program’s increasingly evident flaws. Rather, Vladimír Me¸ciar, the prime minister, wanted to reorient the next round of privatization away from the new financial intermediaries that had done so well in the first round and that largely supported his opponents. In its place he sought a direct sales program that would benefit those who would support him. But by attempting to replace a program that rewarded a broad range of Slovaks with a program that rewarded a narrow group of friends and political allies, he embarked on a democratically difficult project. Me¸ciar was briefly removed from power in March 1994 after the president made a speech criticizing a series of legally questionable privatization decisions, among other things. When he regained power in November, Me¸ciar acted on the knowledge that his political and economic ambitions were incompatible with the democratic institutions he had inherited. The ensuing assault

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on democratic norms, rules, and procedures, while not entirely directed at privatization, nevertheless gave him greater freedom to privatize as he pleased. From late 1994 to summer 1998, Me¸ciar largely succeeded in his privatization goals. Yet, having privatized to friends and allies under increasingly illiberal conditions, his privatization winners then used their influence over the government to secure favorable economic policies in the allocation of credit, the regulation of capital markets, government procurement, and taxation policies. This eventually threw the country into an economic crisis. Far from building the foundation of a more efficient, competitive economy, Slovak privatization became a vehicle for building the wealth and power of a decidedly partisan elite. As in the Czech Republic, democratic politics eventually limited Me¸ciar-era self-dealing. Yet, unlike in the Czech Republic, the battle over privatization and its aftermath was an interparty conflict, a nastier, more dangerous affair than in the Czech Republic with higher stakes. Indeed, the contested front lines closely traced the contours of the larger war for the democratic future of the country. Had the democratic opposition not prevailed in the 1998 election, the country likely would have joined Ukraine in the ranks of postcommunist Europe’s illiberal states.

Voucher Privatization Under ˇ the Carnogurský Government, 1991–1992

With the split of the Movement for a Democratic Slovakia (HZDS) from the Public Against Violence (VPN) in spring 1991, responsibility for priva¸ tization in Slovakia fell to the government of Ján Carnogurský, the prime minister and member of the Christian Democratic Movement (KDH), and his thirty-year-old neoliberal minister of privatization, Ivan Mikloš. While there was room for administrative innovation to account for local differences, in practice, Mikloš administered the voucher program in an almost identical fashion to his Czech counterparts. This was no small accomplishment. The ruling coalition was deeply ¸ split about privatization. The Carnogurský government included Ján Hol¸cík and Jozef Belzák as ministers of industry and economy, respectively. While both men favored a transition toward markets, both had industrial ties and favored a strong sectoral industrial policy in which firms would be restruc¸ tured before privatization. In addition to Carnogurský’s ministers, industry had a strong friend in KDH member Viliam Oberhauser, a founding member of the Federation of Employers Unions and Associations (AZZZ). AZZZ was a peak organization controlled by the communist industrial managers

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(1997: 65). Oberhauser was a key member of the nationalist wing of KDH and had helped author KDH’s alternative scenario for economic reform in February 1991.1 This created difficulties for Mikloš. In the final years of the 1980s, Mikloš studied the liberal Austrian School economics of Friedrich Hayek. At the time of the Revolution, Mikloš had been an economics student and lecturer at the Faculty of Economics at the Economics University in Bratislava. In 1990, Jozef Ku¸cerák brought him into government.2 Given his status as the most visible neoliberal in government and the strongest supporter for federal forms, Mikloš faced the brunt of attacks from both the opposition and the national wing of the ruling KDH. This included surviving several parliamentary votes of no confidence. By winter 1991– 1992, it was increasingly clear that the ruling coalition of KDH and VPN/ODU would fare poorly in the June 1992 election. As the next government would most likely slow privatization and delay the creation of private owners, Mikloš sought to get the voucher program started as quickly as possible—to create a fait accompli of new owners with a stake in continuing the rapid property transformation program. Mikloš was responsible for supplying firms for voucher privatization in Slovakia. He recalls that the threat of dismissal or prosecution under the lustration law helped him to encourage most managers to include significant voucher components in their base privatization plans.3 But he also relied indirectly on the Ministry of Industry as an important source of pressure. Although Minister of Industry Belzák was a vocal critic of voucher privatization, in 1991 and 1992 Belzák used the lustration law to chase the older generation of Slovak industrial managers from the communist nomenklatura ´ udovít Cernák ¸ into retirement or the private sector. L with SNS recalled that upon taking office as part of the next Me¸ciar cabinet, Belzák told him, “I am giving you a clean board. I did all the dirty work.”4 Mikloš further alienated industrial elites by converting what they hoped would be a program of cheap, direct sales of enterprise shares to incumbent managers into a transparent, competitive program in which price was the leading criterion. Prior to the June elections, the ministry sold shares in 189 firms for prices approximating and often exceeding book value (Olsson 1999: 119).5 It would be another six years before the state did as well financially in its direct sales of public property. The first wave of voucher privatization began in October 1991 with the registration of 2.59 million Slovak citizens, almost two-thirds of the adult population, through Václav Klaus’s federal Ministry of Finance. As in the Czech Republic, registration for the program in Slovakia initially lagged until investment privatization companies began to offer a tenfold or greater return

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on the voucher holder’s initial registration fee within a year. Seventy-two percent of Slovak citizen-participants subsequently invested their voucher coupons with investment privatization funds in the first wave of privatization. Bidding on firms began in May 1992 and closed in December. Shares were finally distributed to new owners in April 1993. Despite the efforts of industrial nomenklatura elites, the Klaus voucher privatization program had succeeded in providing the funds’ combined average stakes of up to 40 percent in privatized firms (Olsson 1999: 115–116, 219). Over the next two years, industrial managers worked diligently through AZZZ to ensure that the second wave of voucher privatization would not take place (AZZZ 1996).6

Meciar’s ˇ Second Government, 1992–1994

Me¸ciar’s HZDS dominated the June 1992 election. With tacit support of the SNS, he became Slovak prime minister for the second time. In July negotiations with Klaus, Me¸ciar failed in his bid to form a weak confederation with the Czech Republic. Unable to reconcile Me¸ciar’s concept of a weak confederation with Klaus’s concept of a strong federation, the two electoral winners agreed to replace the federal state with two sovereign, independent republics. After parliamentary approval in both republican assemblies, the countries split peacefully on January 1, 1993 (Innes 2001; Stein 2001). As in the Czech Republic, voucher privatization became one of the more popular aspects of the federal reform program (Dedek 1996: 201).7 This may help explain why the Me¸ciar government, elected in June 1992, completed the first wave as its predecessor had planned. Nevertheless, ´ ubomír Dolgoš, promised a shakeup in Me¸ciar’s minister of privatization, L the next round of privatization. One of the new government’s first decisions was to indefinitely postpone the demand that firms submit second privatization round plans to the Ministry of Privatization. In September 1992, the government program declaration and an associated Ministry of Privatization document spelled out a new privatization philosophy based on state-guided economic transformation. The new con¸ cept was broadly reminiscent of the failed Ceská cesta (the Czech way) initiative put forward by Czech energy sector industrialists. Rather than emphasize the rapid creation of new owners, the state would now single out strategic fields where it would intervene to protect the national interest through the state restructuring of enterprises before, or in place of, privatization. Branch ministries would design and coordinate restructuring plans with the assistance of the state-owned financial sector.

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This concept also favored direct sales to incumbent managers. Price was no longer the dominant criterion in evaluating bids on companies; first installments were lowered from 30 percent of the price to 10 to 15 percent, and payment periods could be up to fifteen years. Voucher privatization would only be used as a residual method (Olsson 1999: 119–120).8 Similarly, the threat of lustration quickly diminished under the new gov¸ ernment. Mikloš asserts that Me¸ciar and his minister of economy, Cernák, reappointed nomenklatura managers that had been lustrated by ¸ ¸ himself relates that Me¸ciar frequently Carnogursky‘s government.9 Cernák paid little attention to his appointees’ lustration certificates in his personnel decisions.10 Me ciar ˇ and the Role of the HZDS

Little privatization occurred under Dolgoš in the first six months of 1993. Rather, Me¸ciar focused his energies on consolidating control over his cabinet—pushing out co-HZDS founder Milan K¸nažko, who was a mar¸ ginal threat to Me¸ciar for party control, and minister of economy Cernák. As a K¸nažko protégé, Dolgoš soon found himself in constant conflict with Me¸ciar—most notably over whether vouchers should have any role in the second round, when it started. Me¸ciar felt they should not, while Dolgoš sought to put aside about one-third of corporate shares for voucher privatization. On June 12, 1993, Dolgoš lost an HZDS-engineered vote of no confidence and stepped down.11 ¸ The departures of independent personalities like Cernák, K¸nažko, and Dolgoš left Me¸ciar in more solid control over HZDS and the government, but it also made his parliamentary majority vulnerable to future defections. Nevertheless, Me¸ciar stepped up his efforts to replace his colleagues with his personal loyalists—particularly in the Ministry of Privatization and the National Property Fund (FNM) (Deegan-Krause 2006: 25). At that time, the Ministry of Privatization coordinated the privatization decisionmaking process, while the FNM was a fully state-owned joint stock company charged with distributing shares to their new private owners. After corporatization, FNM appointees represented the state’s interest as a shareholder at general assemblies of corporate shareholders. In 100 percent state-owned companies, FNM was on paper, at least, in complete control of the firm. Control over the FNM would give the prime minister control over corporatized firms. Attempts to gain direct governmental control over these two institutions brought Me¸ciar into sharp conflict with President Michael Ková¸c, another cofounder of HZDS.12 To replace Dolgoš at the privatization ministry,

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Me¸ciar chose a close associate, Ivan Lexa. Having backed Me¸ciar in the dismissal of K¸nažko, Ková¸c now balked. Citing Lexa’s inexperience and potential conflicts of interest with his nomenklatura father (a communistera central planning agency hard-liner), the president refused to approve the appointment. Me¸ciar responded by giving Lexa the post of state secretary of the Ministry of Privatization (the highest ministerial position not requiring presidential approval) and assumed the responsibilities of minister himself. One of Lexa’s first privatization decisions as state secretary in July 1992 was to approve his father’s participation in the privatization of Považské mlyny a cestovinárne, a.s., with a personal stake estimated at up to 1 billion Sk (then about US$30 million) (Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996: 17). While Me¸ciar consolidated power over Slovakia’s privatization and property control mechanisms, funds from the first round of privatization began to assert some clout in shareholder meetings. Enterprise managers had established a few funds.13 Most notably, Slovakia’s largest company, Východoslovenské železiarne (VSŽ; Eastern Slovak Steelworkers), had established CassioviaInvest fund, which had the marketing clout to acquire more than 10 percent of VSŽ shares. But most funds—and hence a large portion of corporate power—were in the hands of enterprise outsiders, a fact that was increasingly resented by industrial management (AZZZ 1996; Miklos 1995: 64; Olsson 1999: 279, 283). In contrast to Klaus’s promise that voucher privatization would disperse ownership widely, leaving managers with significant influence, funds amassed a 40 percent stake in privatized firms and, from the perspective of incumbent managers, carried unwelcome clout. Battles soon emerged over which would be dominant in determining the overall strategy of the company, the shareholder-dominated supervisory boards or the managementcontrolled boards of directors. Me¸ciar’s allies came to feel that the most influential funds were, as subsequent FNM president Štefan Gavorník put it, “owned by the opposition” (Olsson 1999: 118). While not technically true, by the end of the year, industrial managers and fund-appointed board members began to run into sharp conflict over the day-to-day management and long-term strategy of privatized companies. The AZZZ made the halt of a second round of voucher privatization its number one priority. Me¸ciar obligingly repeatedly pushed back the start date for the next round of voucher privatization. In fall 1993, Me¸ciar complemented his firm grasp of the Ministry of Privatization by putting personal loyalists on the board of FNM. Between December 1993 and March 1994, his indirect control over state shares al-

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lowed him to replace enterprise board members and managers of twenty-one Slovak companies that failed to show sufficient loyalty to HZDS. Me¸ciar claimed that he was simply replacing opposition-linked managers from the VPN-KDH era with more independent managers. Indeed, he accused parliamentary opposition leaders “straight into the eye, in front of everyone, that each one of them is linked with one of the twenty-one major Slovak corporations in which we intervened. And this is the problem.”14 Me¸ciar was possibly correct in his assessment. While in power, KDH appointed people to the boards of leading Slovak state firms. Yet, it was unclear whether they were now being removed because they were acting as KDH clients or due to their reluctance to serve HZDS interests. Indeed, the KDH-era manager of oil refiner Slovnaft, a.s., was allegedly replaced after he refused minister of the economy Ján Ducký’s demands that he subcontract out services to HZDS-linked firms.15 By winter 1994, Me¸ciar’s increasingly personal consolidation of party and governmental power had alienated too many of his own party members. By February 1994, a last remaining block of HZDS deputies led by HZDS cofounder Jozef Morav¸cik appeared ready to follow other former HZDS members and allies into the opposition. The threat of losing power may have led to a subsequent wave of direct sales. Starting with the midnight privatizations of February 1, 2004, Lexa sold forty-four companies with a book value of US$96 million for only US$22 million. The decisions were notable for their lack of transparency, conflicts of interest, and advantageous terms to the purchasers—many of whom had close ties to the government. Thirteen were subsequently annulled by the successor government for contravening the Large Scale Privatization Act of February 1991, but virtually all of the privatizations were suspect. The beneficiaries fell among a very limited range of politically connected individuals—from the wife of a leader of SNS to Me¸ciar’s own minister of finance, Július Tóth (Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996; Olsson 1999: 121–122). A March 11 report of a commission investigating the privatizations triggered the departure of the dissident HZDS faction led by Morav¸cik and a parliamentary vote of no confidence in the government. In his speech before parliament, HZDS cofounder and Slovak president Ková¸c openly accused Me¸ciar of a lack of transparency and clientelism in the privatization process, among other things (Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996; DeeganKrause 2006: 25). Me¸ciar and Lexa’s hurried attempt to reorient Slovakia’s privatization framework to favor political and economic insiders had run afoul of the opposition’s effective use of liberal democratic institutions and norms.

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When next he gained power, Me¸ciar would attack these opposition resources directly. VSŽ and the Slovak Way of Privatization

One of the last acts of Me¸ciar’s 1992–1994 government helps illustrate both the zero-sum nature of privatization and its growing politicization in Slovakia. In December 1993, the state exercised its shareholder rights to remove President Zoltán Berghauer and other top managers from the executive management of VSŽ, Slovakia’s largest commercial entity. Berghauer had cofounded AZZZ and signed industry’s antireform petition of March 1991. Me¸ciar claimed that the top management change was a technocratic decision made through consultations with high-ranking bank and industrial managers.16 But he did not hide the fact that the change was to reduce the “unwarranted influence” of “opposition parties” in Slovakia’s largest enterprise.17 Berghauer and other purged VSŽ managers protested the move, citing a history of political manipulation and threats by HZDS toward VSŽ management. The source of the claim directly attacked Tóth, Me¸ciar’s minister of finance. Tóth had been VSŽ’s vice president of finance until he had resigned to join Me¸ciar’s government. According to Berghauer, Tóth allegedly became enraged when Berghauer and VSŽ’s management refused to agree to an HZDS member on the VSŽ Board of Directors. Tóth allegedly responded by demanding that the two top VSŽ officials resign due to their political support for KDH and other political opponents of HZDS.18 Tóth later asserted that the Berghauer team had been stripping assets from the company. Through control of both VSŽ and collaboration with an independent trading company, they could then siphon profits out of VSŽ by overcharging for supplies and underpaying for products.19 Perhaps to cut these alleged sales out of the revenue loop, or maybe to cut his allies in, Tóth’s new management team set up a new VSŽ-owned sales company to oversee exports responsible for 80 percent of VSŽ revenues.20 As minister of finance, Tóth, along with Lexa, state secretary, orchestrated the purchase of a 9.52 percent share of VSŽ stock through a new private company, Manager, a.s., established by five VSŽ board members, including prominent HZDS member Alexander Režes. The purchase was questionable for its conflicts of interest, advantageous terms, and timing. Again, in accordance with the government program, the shares were sold to domestic entrepreneurs at a substantial discount with a generous payment schedule. The discount on the current share value of the package was US$36

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million (Olsson 1999: 122). After a 10 percent down payment, Manager, a.s. would pay the rest in yearly installments over five years. Manager’s members each made their down payment with an interestfree US$62,000 loan from the Košice-based Priemyselná banka (Industrial Bank), whose controlling shareholder was, in turn, the VSŽ-controlled fund, CassioviaInvest (Olsson 1999: 223). Priemyselná banka, moreover, received these funds from Banka Slovakia, the repository and investment arm of the FNM. In short, Manager borrowed FNM funds to buy shares from the FNM that in turn benefited close associates of its directors and the man responsible for their appointment—Me¸ciar.21 The timing was also controversial. The Me¸ciar government received the proposal to privatize the VSŽ shares to Manager on March 7 and the government approved the request on March 11—the day on which parliament finally issued a vote of no confidence of the Me¸ciar cabinet. The FNM and Manager signed the agreement on March 14, the day the government stepped down. On March 17, VSŽ held a general assembly at which the now former minister of finance and FNM board member Tóth was elected chair of VSŽ’s Board of Directors. Režes would subsequently become minister of transportation in Me¸ciar’s next cabinet. Supporting the vote were VSŽ’s investment privatization fund (IPF) CassioviaInvest as well as VÚB Invest, the investment company of Všeobecná úverová banka (General Credit Bank [VÚB]), Slovakia’s largest state-owned bank. Ironically, oversight responsibility for VÚB had, until four days earlier, lay primarily with Tóth’s Ministry of Finance.22

Meciar’s ˇ Opposition Takes Power, March–November 1993

A five-party caretaker government under the leadership of HZDS defector Morav¸cik formed in mid-March, promising to restore transparency and accountability to the privatization process and to relaunch the voucher privatization process as soon as possible. This was to be done before new elections at the end of September. The coalition fought, however, over how to restore confidence, transparency, and speed to the privatization process. Nevertheless, Kevin Deegan-Krause demonstrates how the new coalition allowed itself to be held accountable to competitive political forces (2006: 26). The recent experience with Me¸ciar may have taught delegations a good lesson in the dangers of overconcentration of power—particularly in the areas of property management and privatization. The new five-party coalition was fractious and ideologically incoherent. This influenced privatization. On the one hand, the formerly communist Party of the Democratic Left (SDL’) sought to maintain Me¸ciar’s direct

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sales privatization, but use it to reward its own allies within Slovakia’s excommunist nomenklatura. The Ministry of Privatization, however, was now led by Milan Jani¸cina, a lawyer from the center-right Democratic Union (DU). He sought to ensure that any direct sales would be a rule-governed, multiparty competitive process—not something to be run exclusively by SDL’ dictates.23 SDL’ did, however, secure an agreement to subordinate the importance of price in the sales and emphasize instead employment and future investment commitments (Olsson 1999: 124). Corruption may have been possible in the final sales, but the number of competing interests in the decisionmaking process ensured that the foxes guarding the hen house would keep each other in line (for more on this dynamic, see Grzymala-Busse 2008). Still, the program was not unimpeachable. As with the Manager purchase of VSŽ, most of Jani¸cina’s direct privatization sales of fifty-four Slovak enterprises occurred after elections had delivered a strong plurality to HZDS, but before Me¸ciar had formed a government.24 The government also conducted a public tender for the government’s 24.9 percent share in VSŽ, attracting interest from nine companies, including the Austrian bank Creditanstalt. Internal coalition bickering over the final buyer led the government to delay the final decision until it lost power (Olsson 1999: 222). Throughout the summer of 1994, citizens, center-right coalition parties, brokerage firms, and IPFs clamored for a second wave of voucher privatization. Jani¸cina fought with SDL’’s minister of the economy, Peter Magvaši, who was also an AZZZ member, to ensure that there would be enough property offered to make the project worthwhile. In preparation, the Ministry of Finance issued voucher booklets to 72 percent of Slovak citizens (90 percent of those eligible). This was a significantly higher participation rate than the first wave. Jani¸cina secured assets valued at US$1.96 billion for the voucher program, making each voucher booklet potentially worth US$593 (19,500 Sk). After another aggressive campaign from the funds, 58 percent of the voucher holders traded their points for shares in IPFs (Olsson 1999: 124–125). If the second wave of voucher privatization was completed, managerial insiders would cede significant additional economic power to the funds.25

Privatization Under Meciar’s ˇ Third Government, 1994–1998

The Morav¸cik government was short-lived. SDL’ had secured early elections. In the ensuing campaign, however, the center right fragmented among a range of competing personalities. A number of opposition parties

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failed to cross the 5 percent threshold in the September–October 1994 vote. Others did poorly: Morav¸cik’s Democratic Union (DU) received 8.6 percent, KDH 10.1 percent, the ethnic Hungarian Coalition 10.2 percent, and SDL’ 10.4 percent. HZDS won a 35 percent plurality. This was less than in 1992. Yet, as 13 percent of the electorate voted for parties that did not pass the 5 percent threshold, the ideological weight of the next parliament shifted sharply back toward Me¸ciar and national-populism. After a month of negotiations, HZDS formed an ideologically awkward coalition with the two smallest delegations in parliament: the extreme right SNS with 5.4 percent, led by the garrulous Ján Slota,26 and the extreme left Association of Slovak Workers (ZRS) with 7.34 percent (Mesežnikov 1997: 50). To discipline the coalition, Me¸ciar could use the threat of an alternative coalition with the SDL’ (Innes 2001: 262). Critics speculated that the brown-red wings of the new ruling coalition were held together only by the promise of privatization benefits (Mikloš 1997: 64). The National-Populist Privatization Concept and Its Implementation

Me¸ciar’s privatization policies formally settled the long-standing battle between neoliberals and gradualists over privatization policy, but in reality, this ideological battle stood proxy for an underlying clash of interests between enterprise outsiders and incumbent firm management. Gradualist concepts were thus hijacked, to an extent, and combined with xenophobic nationalism to benefit the governing coalition and its allies at a growing cost to the public. The formal theory underlying the Me¸ciar government’s privatization program echoed the Dolgoš strategy of fall 1992. The government would work closely with incumbent industrial managers to achieve ownership patterns that would be most appropriate for a coordinated industrial policy. The state would integrate equity transfer, credit, and other policies in ways that would boost the strength of Slovak national firms on world markets and minimize transformational pain at the enterprise level. The variety of capitalism officially envisioned was much closer to a continental-style, state-coordinated market economy than a more hands-off, liberal market economy. However, Slovak industrial leaders at AZZZ also invoked the Asian development model to explain what they were trying to accomplish.27 Insiders Ascendant

In practice, Me¸ciar’s coalition privatized the privatization process and directed capital markets regulation to benefit incumbent managers,

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coalition members, and allies at the expense of enterprise and pollitical outsiders (Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996; Mikloš 1997, 1998). The new majority began to work even before Me¸ciar formed a government. In an overnight session of parliament on November 3–4, 1994, the new coalition passed legislation that secured exclusive control and oversight of privatization, the state media, and the secret service (Szomolányi 1997: 10). An amendment to the 1991 Large Scale Privatization Act transferred the right to propose and decide on direct sales from the Ministry of Privatization to the relatively less transparent FNM (Act 369/1994). The majority then stacked the FNM’s Presidium and supervisory board with coalition officials and cancelled Jani¸cina’s direct sales (Act 370/1994). In five cases new property owners had already taken legal possession of their assets from the state (Olsson 1999: 126). This risked violating both international human rights law and the Slovak Constitution.28 The transfer of power to the FNM had important implications. The Constitutional Court later ruled that as a joint stock company, the FNM did not have to submit to government review or regulatory oversight. Hence, it was exempt from oversight by the supreme government control body that could oversee and audit state agencies. Even had it not been exempt from oversight, however, the November 3–4 “night of the long knives” removed opposition parliamentarians from the oversight committee. The ruling majority was thus fully responsible for monitoring itself (Deegan-Krause 2006: 29).29 While extolling the virtues of a state-directed transformation, Me¸ciar provided the new measures with a neoliberal cover story. He claimed that insulating the privatization process from opposition would allow the FNM to make decisions according to technocratic criteria, free from political influence. This, in turn, allowed him to claim in 1998, when the damage was done, that although he still agreed with his concept of privatization, he had not been responsible for its administration.30 Me¸ciar initially indicated that the second wave of voucher privatization would go ahead, although with less property than Jani¸cina envisioned. In July 1995, however, parliament cancelled voucher privatization (Act 190/1995). Voucher booklets could now be exchanged for a bond with a face value of 10,000 Sk (US$312) to be redeemable in 2001 or on the bearer’s sixty-fifth birthday and with an interest rate equal to the discount rate of the National Bank of Slovakia (NBS). Proceeds to meet the bond obligations were to come from FNM income from sales of state property— a promise that the FNM’s new privatization policy of selling to domestic industrial managers at a deep discount made impossible to keep. AZZZ took credit for the cancellation of vouchers.31 A Constitutional Court decision overturned parts of Act 190 in late 1996 (Zavacká 1997: 164). By that time, however, the FNM had already priva-

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tized most of Slovakia’s remaining nonstrategic industrial enterprises. Even had the government wanted to relaunch the voucher program, it would have had to renationalize private properties to find adequate assets to make the program work. An additional measure passed in July 1995 enhanced the government’s capability to coordinate a state-directed industrial policy through the Strategic Enterprises Act (175/1995). The purpose of the act was to preserve the public interest in crucial Slovak industries. First, twenty-nine firms would be exempt from privatization altogether. This included the fundamental sectors of the economy, including telecommunications, energy, and the defenserelated engineering sector. The list of strategic companies, made public in summer 1996, also included some questionable strategic firms, such as health spas.32 All told, the Strategic Enterprises Act reduced the book value of assets remaining to be privatized by half (Olsson 1999: 130). A second, legally controversial provision of the act forced an additional forty-five private firms to transfer a golden share to the firm’s founding ministry—in most cases, to Ducký’s Ministry of the Economy. The Constitutional Court overturned this prescription in April 1996 as a clear violation of property rights, but tellingly, the owners of major pro-HZDS firms, like Slovnaft, had failed to give the state ownership rights over the golden share. Their reaction gave credence to the neoliberal expectation that privatization—even via a highly politicized process—had produced independent agents with the potential, at least, to resist government policies that hurt their material interests (Gould and Szomolányi 1997b). In November 1996, the Constitutional Court also annulled parliament’s transfer of privatization powers to FNM (Act 370/1994). The court argued that the act had illegally abrogated the state’s responsibility for the transformation of state property. The court stopped short of retroactively annulling the FNM’s actions, however. Stripped of its exclusive prerogative over direct sales, the HZDS-controlled FNM continued to serve its clients through public auctions of shares from the FNM portfolio. While share auctions are a relatively uncontroversial privatization mode, critics allege that the FNM limited access about the time and location of the auction to all but the intended buyer (Mikloš 1997: 67–68).33 Coalition Control over Direct Sale

Between January 1994 and November 1996, the FNM privatized at a furious pace. While Act 370/1994 removed privatization from the government’s portfolio of responsibilities, coalition officials and industrial insiders from AZZZ retained close control over the process. Two FNM officials, HZDS

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member and FNM chairman Milan Rehák and cochair and director of the Direct Sales Section Ján Porvazník, were responsible for executing Presidium decisions. These were closely controlled by the ruling coalition. Junior coalition partner ZRS had formal responsibility for the privatization process—ZRS member Peter Bisák ran the Ministry of Privatization while ZRS vice chairman Štefan Gavorník chaired the Presidium. Gavorník attests, however, that his influence was minimal: while HZDS had no seats on the nine-member Presidium, AZZZ members held six seats and hence a majority of the votes—and they supported HZDS (Haughton 2005: 64). Understandably, now that AZZZ influence was secured, incumbent managers who had previously been skeptical about privatization became strong advocates (Haughton 2005: 35). According to Sharon Fisher, regional committees of five coalition representatives determined properties to be sold and top coalition officials made final decisions at coalition meetings every Wednesday at 6:00 p.m. (2006: 88–89).34 Allegedly, the meetings rarely considered the business merits of the proposal—or even how the sale would further the official goal of coordinated industrial restructuring. As Gavorník recalls, “We were . . . lobbying for those who were coming to us.”35 Yet, Gavorník adds, “not even a nail was sold without Me¸ciar.” Milan Cagala, an HZDS-appointed FNM Presidium member, confirmed these allegations.36 More broadly, members of the ruling coalition were open about clientelism (Mikloš 1997: 66–67). As minister of the economy, Ducký (HZDS), explained, “every government gives advantages to those groups that cooperate with them. This is not controversial.”37 Yet sales went beyond clientelism to open self-dealing—including sales to leading ruling coalition politicians and their family members. As Gavorník admitted, “Of course there are [politicians in the privatization process], and I know about them, but I won’t tell. After all . . . every citizen has a right to take part in privatization” (Deegan-Krause 2006: 277–278). Participants in the FNM’s direct sales program typically received terms similar to the midnight privatizations of February 1994. Buyers—usually incumbent managers—would receive the company for as much as one-third, one-fifth, or even less of its book value. In practice, the typical sale required a 10 to 15 percent down payment, often using money borrowed from a stateowned financial institution. Moreover, installments on the purchaser’s debt to the FNM were usually spread over ten years and deductible from the company’s tax bill. These terms and often the buyers themselves were also frequently kept from the public. In the case of the illegal sale of the strategically listed and highly profitable oil extraction and storage company Nafta Gbely, a.s., the

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new owners of the company remained a matter of intense speculation among opposition politicians and the press. The official address of the purchasing company, Druhá obchodná, a.s., was initially an abandoned building. Vladimír Poor, the Trnava region’s HZDS chief and a member of the regional coalition privatization committee, later admitted to being a primary beneficiary of the deal along with a close Me¸ciar aide (Fisher 2006: 93–94; Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996). FNM president Gavorník later alleged that Poor was able to meet the company’s 575 million Sk (US$18 million) purchase price simply by raiding the company’s 1,075 million Sk (US$34 million) capital account. If Gavorník is right, Poor used the firm’s bank account to buy the firm for himself. Prosecutors later charged Poor with tunneling 300 million Sk (US$ 9.4 million) out of the company, but dropped the charges. In the end, the circumstances of the company’s privatization were never fully investigated, but Poor voluntarily returned the company to the state.38 In another controversial case, the FNM sold a controlling stake of Slovnaft, Slovakia’s oil refinery, to Slovintegra, a company owned by Slovnaft’s director, Slavomír Hatina, and nineteen other managers. Hatina was a financial backer of HZDS and bought 39 percent of the company at an 80 percent discount over the currently traded price. The initial down payment, moreover, was only 1.56 percent of the sale value. The FNM soon knocked down the sale price by an additional 84 percent to reward management for meeting its promised investment and employment targets (Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996: 18). The privatization of Slovakia’s largest company, VSŽ, also continued apace under Me¸ciar’s direct sales framework. In 1995, junior coalition member ZRS engineered a sale of 10 percent of VSŽ shares to Hutník, a company formally owned by VSŽ’s union members, but strongly under the influence of Režes, minister of transport until 1996. Again the price was a fraction of the real value of the shares and paid on a generous installment plan. Hutník then collaborated with Režes to form Ferrimex, a company that purchased another 15.4 percent on extraordinarily generous terms (Olsson 1999: 223– 225). The deal cemented Režes’s control over the enterprise. Režes responded by essentially barring minority shareholder VUB kupón (an investment company set up by Slovakia’s state-run savings bank) from receiving any information about the health and activities of the firm (Olsson 1999: 182). Nationalism in Privatization

The Me¸ciar government employed popular economic nationalist and xenophobic rhetoric to justify its choice of a privatization program. SNS campaigned in 1994 on a promise to protect Slovakia from “impoverishment” at

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the hands of foreign investors (Fisher 2006: 89). The subsequent 1995 government program declaration promised to privilege domestic entrepreneurs over foreigners in the privatization process. These entrepreneurs would then deal with their assets as they saw fit in what Me¸ciar correctly predicted would be a “third wave” of privatization to foreigners (Mikloš 1997: 65). In practice, Slovak government officials remained deeply suspicious of foreign direct investment (FDI) and often sought to block foreign partnerships. “We just want to avoid them coming in and closing [the company],” remarked one FNM official in an interview with the author. “Investors only come to misuse companies and disappear.”39 One example is notable for its senselessness: a foreign advisor to the government related that he worked with an entrepreneur to acquire a strategic foreign partner to modernize and expand production of his product line for export abroad. While the entrepreneur was not explicitly prohibited from signing the deal, he received several telephone calls from top officials in one ministry warning him that he would be held fully accountable if even one Slovak lost his job as a result of the investment. He lost his nerve and cancelled the contract. The enterprise thus remained in debt and was unable to raise the money on its own for modernization; nor was it able to make its own marketing contacts abroad. The advisor noted that this was typical of the Me¸ciar government’s attitude toward foreign joint ventures.40 The combination of national capitalism and knee-jerk nationalism cost Slovakia dearly. Joint ventures with multinational corporations were at that time leading the deep industrial restructuring of Central Europe. They had the capital, marketing networks, and technology to outperform domestically privatized companies, and they were far outperforming firms that remained in state hands, measured in both production increases and productivity growth (Gould and Szomolányi 1997a). Despite this growing record of success, the ruling coalition sold a mere five companies to foreigners out of a total 347 direct sales (Olsson 1999: 133). On a per capita basis, by 1998, Slovakia received one-half the FDI of Poland, one-third the FDI of the Czech Republic, and only one-tenth of the FDI in Hungary (Gould and Szomolányi 2000: 58). This was a lost opportunity for the public. Over the next few years, new owners would effortlessly enrich themselves by flipping their cheaply acquired companies to international capital—realizing for themselves gains that should have gone into the FNM accounts to meet its new privatization bond obligations (Fisher 2006: 94). Insider-Controlled Capital Markets Regulation

Having gained control over the privatization process, incumbent managers pressured the government for favorable capital markets policy. Throughout

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1994 and into 1995, investment privatization companies had clashed with incumbent managers. As Michael Olsson relates, the managers wanted the new owners to contribute capital, while the managers continued to control the direction of the company. The new fund owners, by contrast, sought to pressure the incumbent managers into improving cost efficiency, technological and organizational restructuring, and marketing. It did not help that the funds with diverse portfolios did not have sufficient expertise to cover all the forms in their portfolio. Fund representatives were often barely out of university and entirely lacking in real experience. A cultural clash developed between the older generation of industrial managers—most of whom had their start in Slovak industry in the 1960s and 1970s—and the young men from Bratislava (Olsson 1999: 182). Government actions in 1995 wrested industrial control from the funds back to the industrial managers. Incumbent managers began to use the direct sales process to turn the tables at meetings of general shareholders. Olsson writes, [M]anagers who acquired a large chunk of shares on soft terms from the FNM all of a sudden lost all respect for other minority owners. In fact, during the course of 1995 and 1996, funds could only sit by and watch how control of companies slipped through their fingers as managers or other domestic industrial groups took over. (1999: 182)

The government also intervened in capital markets to further tilt the balance of power toward management. Legislation in 1995 reduced the maximum stake investment privatization companies could hold in a company from 20 to 10 percent. It also prohibited investment privatization companies from placing officials on a company’s board of directors. This weakened the ability of fund-dominated supervisory boards to monitor the day-to-day actions of company managers. Parliament also passed capital markets regulation in 1996 that reduced the transparency of capital markets transactions and all but eliminated minority shareholder rights. Ková¸c returned the legislation, demanding better protection for minority shareholders. Ironically, the funds’ managers were not necessarily in favor of a better regulated market. The Slovak capital market had all the shortcomings of the Czech market described in the last chapter. Given the general lack of liquidity of the market and the ability of controlling owners to expropriate value from minority shareholders without penalty, it soon became clear that a passive portfolio stake in all but the few blue chip companies made little sense. Fund managers found they could best make money by secretly ac-

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quiring a controlling share of companies in unregistered, off-market trades of physical paper shares and then selling them at a profit to a strategic investor. A more transparent market would actually undermine this strategy. As in the Czech Republic, a number of fund managers were somewhat ambivalent about reforms that might make passive portfolio investment safer and profitable (Olsson 1999: 184–185). Yet, the ruling coalition made things worse. It sought to reduce the funds to a portfolio role even as it actively undermined minority shareholder rights. Ministry of Finance capital markets regulator Magula testified on behalf of minority shareholder rights in front of parliament—much to the disappointment of top AZZZ managers. A better law was passed in 1997.41 Still, the new law allowed controlling shares to be achieved anonymously in off-market trades.42 But, remarked one broker philosophically, “at least we have rules.”43 Meaningful portfolio investment never returned, however. Investors avoided Slovakia’s collective investment funds after Magula single-handedly destroyed a rapidly growing collective investment industry in 1996 led by mutual funds. Unlike the privatization funds, the mutual funds’ managers gathered people’s savings and invested them in the market and other assets. The pioneer was Prvá slovenská investi¸cná skupina, a.s. (First Slovak Investment Company [PSIS]), an open-ended fund into which citizens could deposit and withdraw like a checking account. By early 1995, PSIS’s Sporofund had over $50 million in savings invested.44 It was also well run and had done a reasonable job at building shareholder value within its portfolio. But in fall 1994 it used savings to invest in citizen voucher booklets— an asset it argued was a form of state security and hence a legal investment. Over 750,000 Slovaks signed up for the PSIS voucher privatization funds. Had the second wave of voucher privatization gone forward as planned, PSIS would have become the second wave’s largest owner of shares in Slovak enterprises. However, PSIS owners were also strong contributors to the DU—the party of Jani¸cina and Morav¸cik—and owned the independent daily newspaper SME. Both its political orientation and its potential economic power were a threat to the ruling coalition and its industrial allies. In spring 1995, the Ministry of Finance revoked PSIS’s operating license. Courts found the measure illegal and ordered that the ministry restore the license, but the ministry simply revoked it again and transferred control of the company’s successful Sporofund portfolio to Harvard Investment Company. In the face of a massive investor withdrawal from the Sporofund, Harvard liquidated the fund and paid off savers about half of what they had put in (Olsson 1999: 187–190).45

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The Coalition Assault on Democracy, 1995–1998

Me¸ciar’s coalition could not have captured such close control over the privatization framework without a significant attack on the political and civic institutions. Hence, while Slovakia’s democratic decline from 1994 to 1998 was not exclusively caused by privatization, it was certainly linked. Indeed, it is unlikely that the ruling coalition and its allies would have fought so hard had the nation’s most lucrative assets not been available for appropriation. After ad hoc encroachments on democratic norms in 1993–1994, between late 1994 and 1998, Me¸ciar’s parliamentary majority reduced Slovakia’s formal democracy to an illiberal shell verging on competitive authoritarianism. A permissive cause was the majoritarian nature of the Slovak constitution. Led by a strong executive and unhindered by a weak presidency already on the defensive, Me¸ciar’s majority sought to override the remaining checks posed by the Constitutional Court, the political opposition, civil society, and regional and municipal governments. This enabled a reorientation of the privatization framework toward political and economic insiders, but it also endangered horizontal accountability—the country’s internal balance of institutional power (Deegan-Krause 2006; O’Donnell 1994). Me¸ciar’s squabble with the presidency was the most visible aspect of the encroachment. Ková¸c’s 1993 veto over Me¸ciar’s choice of Lexa to run the Ministry of Privatization marked the beginning of a running battle between the government and the president. The conflict took on added intensity during Me¸ciar’s third government. Ková¸c did not have much institutional power to start with. His repeated vetoes of parliamentary acts were quickly overridden by a simple majority—entirely in line with the Constitution. Yet, Me¸ciar sought to further weaken and discredit the president. An important part of this campaign was the Slovak Information Service (SIS), Slovakia’s secret intelligence agency. But first, Me¸ciar had to gain control over it. In the November 3–4, 1994, session of parliament, his majority excluded his opposition from participating on the SIS oversight committee. In spring 1995, parliament transferred power to appoint the head of SIS from Ková¸c to Me¸ciar. Me¸ciar then appointed his trusted protégé, Lexa, to head the service (Deegan-Krause 2006: 29). Over the next two and one-half years, Lexa waged a war of dirty tricks against the president and harassed civil society and independent entrepreneurs. The war reached its climax in August 1995 when someone— possibly Me¸ciar, but more probably Lexa—ordered that the president’s

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son be drugged, kidnapped, and dumped in neighboring Austria. When Robert Remiáš, the confidant of an ex-SIS agent, implicated SIS in discussions with the editor of the leading independent daily SME, Remiáš was assassinated. The government squelched subsequent official investigation of the kidnapping and murder after the investigation began to point to Lexa (Williams 2001: 130–140). The battle between Me¸ciar and Ková¸c ended only after the president’s term of office expired in 1997. As parliament could not achieve the supermajority needed to select a replacement under a clearly flawed constitutional provision, presidential powers fell to the prime minister. Me¸ciar subsequently used his presidential powers to pardon anyone linked to the kidnapping and Remiáš’s murder—despite the lack of any official finding that a crime had taken place (Deegan-Krause 2006: 48–50). The government also encroached on the rights and prerogatives of the opposition, the courts, civil society, and the media. In addition to oversight of the secret service, the November 3–4, 1994, parliamentary session banned opposition MPs from participation on all substantive committees except the environment committee. The coalition further revealed its hegemonic intentions by trying, unsuccessfully, to have former prime minister Morav¸cík’s party, DU, banned from parliament, and by charging President Ková¸c with treason. To safeguard against a repeat of the 1993–1994 defections of Rudolf Filkus, K¸nažko, Ková¸c, Morav¸cík, and others, defectors from HZDS were now treated unconstitutionally. After HZDS cofounder František Gaulider left the HZDS parliamentary club in 1996, HZDS leadership produced a presigned letter of resignation that they had obtained in 1994 to ensure party discipline. The parliamentary majority then stripped him of his parliamentary mandate, barred him from the building, and replaced him in parliament with an HZDS loyalist. The Constitutional Court ruled these acts to be unconstitutional, but parliament did not reinstate him—another violation of Slovakia’s fragile system of checks and balances. Gaulider also received numerous threats to his life (Mesežnikov 1997: 43; Szomolányi and Gould 1997: 5). Media and civil society also came under intense legal and extralegal pressure from the government and allegedly the SIS. HZDS attempted to monopolize channels for societal interest group representation by creating bureaucratic barriers to their legal operation and by establishing partycontrolled interest groups that competed with independent societal interest groups in their particular field (Malová 1997: 93–113). Similarly in media, parliament’s November 1994 legislation excluded the opposition from any role in oversight over public broadcasting. State-

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controlled mass media and sympathetic newspapers then justified government actions with a torrent of unbalanced coverage, nationalism, xenophobia, personal slurs, and misdirection.46 Things were also tough for the independent media. Following his reporting on the Ková¸c Jr. case, the editor of SME found a dead cat nailed to his door and his car burned. An anonymous leafleting campaign accused two other critical journalists of pornography and pedophilia. A third journalist who looked too closely at the links between Režes and HZDS was beaten up in a Košice restaurant (Innes 2001: 313). Meanwhile, privatization beneficiaries frequently bought and attempted to control the editorial content of the independent media. When VSŽ took over the business daily Národná obroda, for example, the new owners fired the newspaper’s independent-minded editor. Overall, while the independent media functioned effectively, it faced numerous forms of petty harassment from various government agencies (Školkay 1997). Independent news sources, however, did not reach the entire population. In much of the country, the broadcast media was the primary source of information. After the November 3–4 session of parliament, government loyalists ensured that state broadcasting reflected their views, even to the point of collaborating with the SIS to fabricate investigative reports slandering the president. Nor did the most important independent media source, the television station Markíza, initially have the coverage capacity or willingness to acquaint Slovaks with the details of privatization or other ruleof-law issues. Toward the end of the 1996–1998 period, however, TV Markíza did become a crucial source of alternative information in Slovakia (Školkay 1997: 196). As the Me¸ciar government came into conflict with basic liberal institutions and freedoms, the EU, the North Atlantic Treaty Organization (NATO), European governments, and the United States all registered their displeasure with Slovakia’s political processes. The EU, in particular, issued a series of diplomatic démarches as part of its dialogue with applicant countries (Duleba 1997b; Vachudova 2005). In 1996, Freedom House reduced Slovakia’s political rights ranking from “free” to “partially free” (Freedom House 2007). However, the nastiest rap to the government’s knuckles came in July 1997, after the government illegally cancelled a national referendum on NATO membership. The European Commission recommended that Slovakia be excluded from the first wave of EU membership negotiations. While Slovakia was a liberal democracy in form, the Commission opined, it operated differently in practice (European Commission 1997: section 1.3). NATO followed suit and excluded Slovakia from its first round of expansion (Duleba 1997b). The Me¸ciar government dismissed these external critics by questioning the objectivity of their processes and critiquing the patriotism of domestic

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opponents who agreed with the government’s foreign critics. Yet, the blows hurt. Slovakia’s young, urban, and educated citizens were deeply concerned with proving the country’s Western credentials and strongly wished to join Europe’s most exclusive clubs. Thus the EU and, to a lesser extent, NATO put the government in a bind: Me¸ciar could not comply with their conditions and still retain his increasingly politicized and often illegal control over political and economic life. As Milada Vachudova has pointed out, “political power depended on strategies that were incompatible with the EU’s requirements of liberal democracy and comprehensive market reform” (2005: 38). As the September–October 1998 parliamentary election approached, HZDS even appeared ready to jettison free and fair elections. Parliament had amended the electoral law in ways that gave the Ministry of the Interior greater influence in counting the vote, put ambiguous and potentially expandable limitations on the ability of the private media to cover the election, and shackled the ability of small parties or coalitions to participate in the election. HZDS also had the courts review the leading opposition coalition’s eligibility to participate. Had the government applied a literal interpretation of these laws, it could have eliminated a number of important institutions of liberal democracy, including the right to contestation and participation, as well as the right to alternative sources of information. Many feared a fullfledged authoritarian turn.47

Privatization’s Partial Reforms

As in the Czech Republic, Me¸ciar’s privatization program produced stakeholders in dysfunctional economic policies. That this would be the case was not necessarily preordained. The first two Slovak governments retained the basic elements of the structural adjustment program inherited from the federal government. An independent NBS kept the Slovak currency strong, while the first two postindependence governments restricted their fiscal expenditures and preserved a liberalized trade environment. By 1995–1996, Slovakia’s firms were beginning to find new markets in Western Europe. Unemployment, still high at 13 percent, was beginning to inch down. With so much slack in the labor market, inflationary pressures remained acceptable. The major problem was a deliberate coalition policy of politicized structural reform. The years 1997–1998 turned out to be challenging in the global economy. Yet, the network of industry-state-party ties shaped by the insider privatization process and illiberal politics made Slovakia even more vulnerable to a downturn. Missed tax payments, uncompetitive government procurement programs, significant government financial obligations, de-

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layed restructuring, a weakening currency, low foreign direct investment, and a troubled banking sector all contributed to an economic crisis that would cost Slovakia the next three years of growth. Manipulation of Debt

Coupled together, the Czech and Slovak experiences confirm the observation that a government’s capacity to protect property rights and enforce debt contracts is more important to the efficiency of privatization outcomes than the rapid distribution of property rights (Johnson and Shleifer 2001; Olsson 1999). Indeed, while the Me¸ciar government’s privatization policy led to more rapid concentration of ownership than did Czech privatization, it did not produce more efficient behavior. According to interviews with Western financial services experts and equity market actors, Slovak owners often engaged in the same suboptimal behavior as their Czech counterparts, even though they frequently had greater control over their firms. Much of the reason relates to debt and the firms’ low purchase prices. Like Czech firms, Slovak firms carried a large outstanding burden of debt that they were not necessarily pressured to honor. First, similar to the Czech Republic, Slovakia’s bankruptcy law privileged debtors over creditors, reinforcing a persistent trend of overdue liabilities (OECD 1999: 97). Second, and also similar to the Czech Republic, the administration of the first wave of voucher privatization in Slovakia led to an initial concentration of privatized property in the state bank–owned funds. These stateowned banks suffered many of the same conflicts of interest as their Czech counterparts and engaged in many similar practices, like debt loading. The percentage of nonperforming loans in the portfolios of Slovakia’s three state banks rose between 1996 and 1998 from 35 to 43 percent (OECD 1999: 79). Third, privatization in highly discounted client or management buyouts failed to bring new cash or debt relief to Slovak companies. Despite the often symbolic purchase prices and favorable repayment terms, politically connected buyers would often increase debt by borrowing from state banks to make their down payment to the FNM. Privatized firms also frequently stopped paying their taxes. From 1995 to 1998, tax arrears of private firms in Slovakia tripled to a total of about 16 percent of total state expenditures. Fully paid, this would have been more than enough to eliminate the budget deficit (OECD 1999: 54–55). The scarcity of cash in the economy did not bode well for restructuring. Managers privatized their firms only to find themselves apparently condemned to eke out a living at the margins of solvency for years on end. Fac-

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ing such choices, and given lucrative opportunities for cash assets elsewhere, it actually made sense for new owners to strip their companies and return the shells to the FNM before making the first installment payment.48 Another option was to consume the company slowly: meeting its minimal obligations to the FNM and tax office, defaulting on interenterprise debt, and siphoning off the extra cash.49 Officially, the FNM was allowed to control major asset transfers in firms with FNM debt, but in practice, they were too overstretched to monitor all transactions.50 Me¸ciar’s HZDS—through the government—held the ends of the long strings of debt that permeated the economy. Ideally, given its commitment to sectoral industrial policy, these debt obligations should have been used by the government and the Ministries of Finance and Economy to coordinate restructuring efforts. Indeed, the Ministry of the Economy’s official statement on industrial policy made it clear that control over liability networks was a crucial component of its effort to engage in industrial restructuring. The ministry also sought to promote the development of asset networks, “by supporting groupings of enterprises into holdings” to “pool investment resources” (Ministry of the Economy 1997). Yet the reality was that due to coalition permeation by industrial interests, it was the governing coalition’s industrial clients—as well as those firms that could arrange for ad hoc dispensations—that often pulled the strings of Slovak industrial and privatization policy. The result was that state-business networks were used to channel present and future tax revenues into the pockets of politically important industries and individuals. Ironically, after the Me¸ciar government fell in 1998, the successor government picked up these long strings and used them to regain control of many enterprises. Revitalization and Industrial Policy

Interenterprise debt and tax arrears provided opportunities for government manipulation. As noted, the bankruptcy framework privileged debtors over creditors. As most AZZZ members were debtors, there was little incentive for the industrial lobby to support a change in policy. Yet the government also passed a controversial Revitalization Act that granted chosen firms the right to enter into a state-sponsored debt relief program (Ministry of the Economy 1997: 18). The Revitalization Act was designed in conjunction with Ducký’s Ministry of the Economy on behalf of Slovakia’s hard-hit engineering and machinery sectors. Based largely on tax relief, in practice its use was limited to the restructured companies owned by the quasi-private holding company DMD Holdings, a.s., as well as a number of agricultural firms (OECD 1999: 104–105).51

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DMD, run by Me¸ciar’s former minister of finance, Tóth, was an umbrella holding company for a network of former state-run defense manufacturing firms that were most severely hit by defense cutbacks at the end of the Cold War. In addition to restructuring, DMD profited from direct Ministry of Economy support—mostly in the form of encouragement and coordination—for the development of an indigenous automobile supply network (AZZZ 1996).52 While the effects of these direct attempts at industrial policy appeared to be generally well intentioned, they had little positive effect on restructuring the companies involved. Indeed, its impact appears to have been to encourage firms to withhold taxes in hope of tax relief (OECD 1999: 55, 104–105). The program virtually halted marginally successful earlier attempts at defense conversion (Mikloš 1997: 75). Slovakia eventually got its automotive sector, but it took the defeat of Me¸ciar, clear political compliance with the prerequisites of EU membership, macroeconomic stabilization, and significant initial investment incentives to entice foreign automobile producers and supply companies to come to Slovakia in significant numbers (Fisher, Gould, and Haughton 2007). Politicization of Bank Privatization

The FNM’s insider privatization framework raised levels of conflict surrounding bank privatization. In early 1996, Me¸ciar promised to sell Slovakia’s largest state banks to Slovakia’s leading enterprises, most notably VSŽ and Slovnaft.53 Observers quickly pointed out that the likely result of the privatizations would be to decapitalize the banks as owner-firms like VSŽ wrote themselves checks. Hence, while the opposition parties, KDH, Democratic Party (DS), and DU, were officially in favor of privatizing the banks, they formed a onetime coalition with HZDS’s far-left-wing governing partner, ZRS, to get the banks placed on the list of strategic enterprises that prevented their privatization. ZRS really had nothing against bank privatization per se, but they allegedly were upset that HZDS had excluded ZRS clients from buying one of the banks (Olsson 1999: 258). While partially preventing the banks’ capture and potential mismanagement by industrial managers, the banks nevertheless remained undercapitalized. Deeply in need of capital, VSŽ nevertheless proceeded to secure control over Slovakia’s third largest state bank, Investicná a rozvojová banka (Investment and Development Bank [IRB]), through VSŽ’s network of over 147 daughter companies and associated holdings, as well as through the support of the FNM at shareholder meetings (OECD 1999: 77–78, 1998: 29; Olsson 1999: 158). IRB had a troubled portfolio that VSŽ control did little to correct. The state had been using it to keep a nuclear power plant sol-

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vent and to provide subsidies to the construction industry to build apartments for young couples. In 1997, IRB liquidity problems worsened and the bank was forced to borrow internationally at rates driven up by the emerging global financial crisis. The NBS directed VSŽ, as the primary owner, to provide a much-needed capital injection. VSŽ refused. The NBS later suggested that the bank’s deterioration resulted from “serious illegal transgressions that negatively influenced the bank’s activities.” To add to the crisis, the junior coalition partner SNS refused to support a renewal of state support for the construction industry’s subsidized apartment loan program. After more government infighting, IRB failed to meet its depositors’ demands, forcing the NBS to seize it in December 1997 (OECD 1998: 29, 1999: 77–78).54 The VSŽ raid on Slovakia’s financial sector was the logical culmination of insider privatization under illiberal political conditions. Tightly bound together by political necessity, Me¸ciar’s administration provided Rezeš and his network of enterprises insider access to special deals in privatization, taxation, credit allocation (from state financial institutions), and almost every other area where the state intersects economic activity. Moreover, he did this despite open indications of nepotism, corruption, and mismanagement. The final cost to other corporations, the taxpayers, and VSŽ’s more than 25,000 employees was enormous. By winter 1998, VSŽ Holdings had defaulted on its foreign obligations and was facing layoffs and bankruptcy. Me¸ciar’s successor government then used this crisis to regain control of the company and control its growing debt.55 In 2000, the successor government sold VSŽ to United States Steel. Abuse of State Property

Coalition misuse of property included firms that were not yet privatized. Perhaps the most notable case is former minister of the economy Ducký’s abuse of the country’s natural gas company, Slovenský plynárenský priemysel (Slovak Gas Industry [SPP]). A key member of AZZZ and a former communist-era nomenklatura figure, Ducký resigned his position with the government to oversee a systematic tunneling of SPP assets for personal and political use. This included financing FC Slovan—Slovakia’s most famous football team and, ironically, the former Czechoslovak rival to Sparta Praha, a team purchased by VSŽ’s Režes. Ducký would even hand out cash bonuses to reward players for stellar play.56 The full extent of Ducký’s tunneling only became clear after the government fell from power. Ducký died in a still-unexplained assassination in 1999 three days after a probe was launched into his handling of the company (Fisher 2006: 94).

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Slowing Macroeconomic Performance

It is perhaps ironic that, except for privatization, Me¸ciar’s second government largely left the federal reform package intact until 1996 (Mikloš 1997: 63). Favorable entrepreneurial conditions produced a relatively strong recovery in 1994–1996, matching a regional trend. Yet, as the VSŽ case demonstrates, client industrialists began to demand policies that would erode this stability. Ironically, clients often made Me¸ciar’s job more difficult, suggesting that Slovakia’s partial reform equilibrium had morphed from clientelism into outright state capture. The tight monetary policy of the largely independent NBS was a crucial element in the strong macroeconomic performance of Slovakia. Yet, since NBS monetary discipline also significantly raised the cost of credit, maintained the real value of liabilities, and put constraints on fiscal policy, the NBS came under pressure from the Ministry of Finance to be more cooperative with Slovak industrial policy. According to Mikloš, VSŽ president Ján Smerek complained that the NBS’s tight money policy was a form of “disliking VSŽ and, apparently, disliking Slovakia’s development” (Mikloš 1997: 71–72). Under intense industrial pressure, the NBS narrowly escaped an attempt by parliament to place it more directly under government control (EIU 1998: 16–17). Heavy borrowing, low foreign investment, and this attack on the NBS led major investment rating agencies to downgrade Slovak bonds to below investment grade level in spring 1998. This further raised the cost of borrowing.57 By the end of Me¸ciar’s third government, enterprise restructuring in Slovakia had also slowed. Firms that sought an injection of capital had to face, among other things, poorly functioning equity markets, rendering an initial public offering nearly impossible; a government that was suspicious and even hostile to foreign strategic investors; government decisionmaking that frequently violated the equal application of the rule of law; and finally, an increasingly profligate fiscal policy, capped by a costly infrastructure development program that crowded out private investment. By spring 1998, the Me¸ciar government had to finance its cash-starved economy on European markets at the relatively costly rate of 3.5 percent above the London Interbank Offered Rate. It also borrowed short-term domestically at a nominal rate of 28 percent. The high level of domestic borrowing aggravated the credit squeeze on Slovakia’s already strapped enterprises.58 Short-term borrowing to meet long-term debt obligations was the final nail in the Me¸ciar government’s economic coffin. By summer 1998 it was clear that the Slovak performance of the previous year had been financed by unsustainable fiscal spending and borrowing.

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Meciar’s ˇ Electoral Defeat, October 1998

Parliamentary elections in late September 1998 proved a satisfactory denouement to the regime’s VSŽ-led orgy of self-dealing. The government had put in place rules that looked as if the government were equipping itself with the necessary tools for a full-fledged authoritarian seizure of power. No seizure occurred. It is possible that the HZDS did not even consider the possibility. Even if it had, concerted efforts from independent nongovernment organizations (NGOs), regional governmental associations, and a united center-right coalition of parties with the SDL’ helped get out 84.25 percent of the vote and correctly spin the election as a test of Slovakia’s Western European credentials. HZDS won a marginal plurality, but ZRS was in shambles after its lamentable performance as a far-left party in charge of privatization. HZDS tried, but was unable, to lure SDL’ away from the opposition to form a coalition. SDL’ then joined a coalition of parties: the Slovak Democratic Coalition (SDK), Slovak-Hungarian Coalition (SMK), and the new Party of Civic Understanding (SOP) to form a government united by little more than opposition to Me¸ciar and a desire to get into the EU and NATO (Bútora and Bútorová 1999). Slovakia’s privatization winners split deeply during the election. Most of the direct beneficiaries of Me¸ciar’s politicized economic policies remained close to the prime minister. Most notably, VSŽ owner Režes provided the HZDS significant financial support and other perks, including flying the prime minister to campaign events in his private jet and even forcing his football team, Sparta Praha, to wear HZDS jerseys in a campaignrelated friendly match. Režes’s empire was already hemorrhaging money despite having raided two of Slovakia’s leading financial institutions. The IRB had already been bailed out by the NBS at taxpayer expense. This was an indirect subsidy that allowed money to filter into the HZDS campaign. It must have been clear to Režes that only continued industrial collaboration with his political patron would be able to save his fortune. Yet, faced with the gathering strength of the opposition, other Me¸ciar clients were more circumspect—even Trnava’s Poor hinted at his willingness to work with a new government (Gould and Szomolányi 2000). SOP promoted itself as the voice of the independent entrepreneurial community. In interviews, its spokesman strongly critiqued the disastrous economic management of the government and the party promised to uphold the rule of law in economic and political dealings. It sought, however, to establish a safe probusiness middle ground between the polarized camps in Slovakia’s Cold War. Despite this, its founder, Rudolf Schuster, refused any prospect of cooperation with HZDS (Haughton 2005: 71).59 Other entre-

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preneurs continued to support SDL’ and the newly united Slovak Christian and Democratic Union (SKDU) (Gould and Szomolányi 2000).

Conclusion

Having privatized their enterprises through political connections, Me¸ciar’s industrial clients went on to privatize state policy. Rather than demand the rule of law, they sought exemptions; rather than invest resources to restructure, they stripped and tunneled them; rather than act as national champions, they preyed on the financial system. By 1998, the coalition government’s client-based political economy was no longer sustainable. As the economic price grew, the politicization of economic policy became an important additional grievance in the opposition’s political arsenal. Never united, many of the coalition’s economic elites sat on the fence or sought accommodation with the opposition. Others proved firm supporters—particularly Režes’s VSŽ—who must have seen that VSŽ’s financial future was closely linked to government policy. On the whole, Me¸ciar’s politicized privatization did not produce market democrats, but it did succeed in providing economic agents who responded to their own logics of action. These proved to be both a boon and a curse to Me¸ciar during his moment of greatest political crisis. Privatization’s impact on Slovakia’s political liberalization, in short, was at best neutral and at worst negative. Ultimately, it was a united opposition: strategically smart NGOs and a mass mobilization of Slovakia’s voters that finally established liberal democracy in Slovakia.

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7 Postprivatization Entrepreneurs and the Political Economy of Ukraine John Gould with Yaroslav Hetman

Life is unfair, and the unfairness is distributed unfairly. —RUSSIAN SAYING

olitical competition went a long way to helping the Czech and Slovak republics address problems associated with the privatization process. Competition allowed those most hurt by economic dysfunction to challenge the political control of dysfunction’s beneficiaries. In the broader political context, however, Czechs and Slovaks were lucky. First, the rebellious society that drove the Velvet Revolution of 1989 forced the marginalization or liberal transformation of the incumbent communist elite. Second, genuine political liberalization and free elections in June 1990 created space for both political oppositions and civil society to develop to a point where they could challenge new governing elites like Václav Klaus and Vladimír Me¸ciar for power. Finally, and regardless of how traumatic it was for political and economic liberals at the time, the Velvet Divorce of 1993 eventually contributed to political liberalization in Slovakia by decoupling basic policy questions from national identity insecurities.1 After independence, nationalist attempts to associate critiques of government policy with threats to the Slovak nation carried less urgency. In the broader postcommunist context, however, liberal political transitions like the Velvet Revolution were more the exception than the norm. Much of the communist world missed the democratic breakthroughs of 1989 and 1990. In these countries communism did not collapse in the face of

P

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strong societal resistance. Rather, the incumbent elite reworked the old system in ways that preserved their essential interests—generally at the expense of society. Most of these transformations resulted in competitive authoritarian regimes, described in Chapter 3, in which limited political freedoms and formal democratic institutions coexisted uneasily with a political system rigged in favor of power holders.2 In some respects, Me¸ciar’s attempts to establish a political hegemony in Slovakia can serve as a generic model for these illiberal postcommunist countries. Slovakia is, of course, different in many important respects. From the start Me¸ciar had to contend with the established rules and freedoms of a functioning democratic country. In addition, external and especially European Union (EU) pressure on the government to uphold democratic standards gave government opponents a powerful external ally in their resistance to Me¸ciar’s encroachment on democratic institutions (DeeganKrause 2006; Duleba 1997b;Vachudova 2005). Yet Me¸ciar’s attacks on liberal principle, his use of a nationalist narrative to justify illiberal action, and the ensuing regime crisis in 1998 are at least reminiscent of the political dynamics that afterward beset many postcommunist competitive authoritarian regimes. Thus, this is a good place to travel further east and south in our study to examine the role that privatization and other property control policies played in empowering an illiberal postcommunist political elite. The first stop, and the focus of this chapter, is Ukraine, a competitive authoritarian country that because of its partial economic success in the 2000–2004 period serves as an important puzzle for political competition theory. This chapter and the next will argue, following Levitsky and Way (2002), that competitive authoritarian regimes tend to be unstable. First, the existence of limited political freedoms and competitive forms of politics provides a formal, but constrained, outlet for opponents to organize and give political expression to their opposition. Nevertheless, formal institutional bias and informal political manipulation help ensure that the answers to substantive questions satisfy the politically connected. Second, marketization and, particularly, privatization policies produce independent economic agents who might, during crises, exercise their agency in ways that encourage liberal political change. Neoliberal market reformers predict that economic agents will tire of the high economic and political transaction costs of the illiberal political economy and lend their support to a regime promising to build the institutions of some variant of a market democracy. Yet, as we shall see, entrepreneurs whose economic vision includes profitable, deep coordination with the regime will continue to be important proregime actors.

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Third, oppositions can pursue strategies that exploit the fundamental contradictions and tensions of competitive authoritarianism, not least of which include the strategic choices faced by entrepreneurs. This can lead to a regime crisis in which the government must either engage in full repression of the opposition—thus becoming fully authoritarian—or liberalize politically and risk losing at the polls. Often, oppositions can ensure that the regime will find itself without enough support to risk repression. Unable to rule in the face of civic opposition, regime liberalization is the only option left. Our focus on Ukraine provides an interesting variant of this typical pattern of competitive authoritarian crisis. After a period of intensive rent-seeking in the 1990s, economic reforms contributed to a boom in metallurgical and other sectors, driving growth from 2000 to 2004. Close collaboration between the state and regional steel sector interests was part of a relatively successful competitive authoritarian growth model. Yet, its longevity was dependent on continued high demand in export markets. Nor were its benefits evenly spread—the country’s poorer agricultural regions lagged behind, while a growing group of business interests in the capital and elsewhere resented the state’s predatory bureaucratic and politicized economic management. In fall and winter 2004, Leonid Kuchma, the president, tampered with presidential elections to ensure the election of his chosen successor, Viktor Yanukovych, the prime minister. Opposition mobilization and civil disobedience supported heavily by local entrepreneurs and a few dissident oligarchs forced the government into a classic competitive authoritarian dilemma, that is, respect the democratic process and risk losing power or repress the opposition and rule with a fully authoritarian hand. In the end, strategic decisions by the opposition and the indefatigable efforts of thousands of supporters in Kyiv made an authoritarian turn impossible to carry out. Yet, Ukraine’s 2004 crisis was also at least partially a zero-sum conflict over the country’s dominant economic model. Despite robust growth, Ukraine’s business class split over two opposed conceptions of economic governance. President Kuchma and Prime Minister Yanukovich were from the country’s industrialized regions. Yanukovich, in particular, wanted continued state coordination in which policy would be subordinated to the needs of dominant export sectors. Yet, many other leading businessmen and politicians clearly benefit from rents generated from preferential access to state policy—made possible by illiberal political conditions. Opponents, by contrast, advocated a general state disengagement from economic interference and, most importantly, liberal political institutional reforms to

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ensure a less corrupt, self-restraining state. In between these two camps were the opportunists—entrepreneurs trying their best to make the right strategic choice against a background of political uncertainty. This chapter examines the postcommunist political economy of Ukraine in the lead-up to the regime crisis of 2004 and the role of business and political elites in that crisis. The next chapter will examine similar crises in Serbia, Georgia, and Azerbaijan.

The Political Economy of Competitive Authoritarian States

In the early postcommunist period, neoliberal market reformers expected that economic reforms would prepare the path for political liberalism. By helping competitive authoritarian regimes to develop their market economies, robust market reforms would create a new class of entrepreneurs who, motivated by Coasian logic, would soon tire of the overbearing whims of bureaucrats and politicians and demand the institutions of the selfrestraining state. Postcommunist European experience shows, by contrast, that unless a postcommunist state gets its liberal politics right, the economics will be unlikely to fall into place. Without at least some combination of social and political accountability, non-Coasian logics of self-enrichment prevail. Wherever competitive authoritarianism flourished, postcommunist European states suffered an economic train wreck. Worse, those who benefitted most from the derailment prevented attempts to fix the tracks. How then are illiberal postcommunist regimes to liberalize politically? The last decade demonstrates that competitive authoritarian regimes can be quite unstable. Indeed, strong leaders with hegemonic intentions have suffered political defeats in Slovakia (1998), Croatia (2000), Serbia (2000), Georgia (2003), Ukraine (2004), and Kyrgyzstan (2005). At the same time, Azerbaijan slid more deeply into repression in association with the 2003 presidential and subsequent elections, while Russia’s and Belarus’s progress toward greater authoritarian control has been more gradual. The postrevolutionary developments of Ukraine, Georgia, and Kyrgyzstan show that it is difficult to consolidate a liberal regime after the fall of an illiberal strongman. Regardless of their later performance, however, these cases also provide examples of how competitive authoritarianism’s combination of liberal freedoms and formal rules and authoritarianism’s restrictions and informal practice can be hard to maintain over time. For political competition theorists, the competitive authoritarian dilemma has an important but poorly appreciated economic component.

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Under conditions of competitive authoritarianism, economic agents frequently have little choice but to work with the regime on its terms or risk being driven out of business. Yet, entrepreneurs also frequently exploit illiberal politics to secure a politically guaranteed return on their investment. One should note, however, that state-business collaboration is not necessarily dysfunctional. Under democratic conditions, peoples have directed their states to play a variety of important roles in democratic capitalism that can, of course, take many forms (Hall and Soskice 2001). Critics of neoliberals thus rightly point out that the neoliberal reform blueprint (see Chapter 2) seeks to reproduce a specific form of liberal market economy over other democratically compatible varieties of capitalism. They also point out the degree to which international financial actors like the European Bank for Reconstruction and Development have embraced this neoliberal vision in the postcommunist context (Mykhnenko 2005: 84). To the extent that Hellman employed transition indicators to compare the reform progress of different postcommunist political regimes, political competition theorists have perhaps unwittingly contributed to postcommunist scholarship’s neoliberal economic bias (1998). Nevertheless, as noted in Chapter 3, political competition theory was developed primarily in response to neoliberalism’s failure to take political institutional context seriously. The fundamental insight of political competition theory is that robust competition for power—characterized by rule-governed, but uncertain, political outcomes—is a strong precursor of economic success. In principle, political competition theory is agnostic about the varieties of postcommunist capitalisms that emerge. In the 1990s, for example, Czech neoliberalism and Slovenian social democracy both fell within its explanatory scope. It is thus perfectly consistent that democratic societies might prefer a continental-style, state-coordinated market economy over the liberals’ vision. One thing that leaves political competition theorists speechless, however, is sustainable authoritarian economic success.3 More broadly, there has been very little work examining the impact of postcommunist authoritarian political regimes and the development of functioning state-coordinated market economies.4 By and large, the field has dismissed such efforts as state capture leading to inevitable rent-seeking and economic stagnation (Hellman and Kaufmann 2001). Yet, as any observer of Asian development will tell you, interventionist authoritarian regimes can produce strong developmental outcomes.5 Ukraine is an interesting case since its efforts to build a more coordinated market economy in the coal, steel, and other industries can be associated with strong growth results from 2000 to 2005. Yet in 2004, the

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government’s effort to manage a presidential election led to revolt and a classic competitive authoritarian dilemma. This leads to two interesting puzzles. First, what accounts for Ukraine’s transformation from a dysfunctional economic basket case in the 1990s into one of Europe’s fastest growing economies in the 2000–2004 period? Second, why, despite this success, was there at least a partially business-supported revolt in response to the government’s attempt to manipulate presidential elections in 2004? It is also interesting to note, as Vlad Mykhnenko points out, that outside of Kyiv’s middle class, the strongest support for the Orange Revolution—the democratic opposition movement protesting the government’s effort to falsify the fall 2004 presidential election—came from the poor agricultural west. In the more developed, industrial east, entrepreneurs and the middle class largely supported the comparative authoritarian regime—exactly the opposite of what neoliberals would expect (Mykhnenko 2009). Both neoliberal and political competition theory thus have something to learn from the Ukraine case. Whereas political competition theory predicts that illiberal privatization and other partial economic reform policies will produce a rent-seeking elite, neoliberal theory emphasizes private business actors’ independent agency and expects that they will use this agency to build a market democracy. In truth, both dynamics occurred side by side during Ukraine’s 2004 regime crisis. Indeed, Ukraine’s economic elite divided, but why? The contested 2004 election in Ukraine produced both a political and an economic crisis. At stake was the country’s dominant—and relatively successful—development model. As the incumbent government appeared increasingly vulnerable to an opposition victory, many of the country’s economic actors suddenly had to make more complicated calculations of selfinterest, punctuated by deep uncertainty about the future and the best means to preserve their position. Previously well-understood logics of action become blurred with potentially significant penalties for making the wrong choice. For regime supporters, coordinating closely with the state had been a crucial part of a successful development strategy. Other supporters, however, had previously gotten by or even prospered by complying with the regime’s often blatant political and pecuniary economic demands. Yet, the political crisis called the utility of these relationships into question. Many faced significant incentives to switch allegiances—to support an opposition promising liberal political change that would challenge the grip politically connected industrialists had over the state. There are many reasons why economic agents might take the risk of supporting the opposition during a regime crisis. While the beneficiaries of

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Ukraine’s state-coordinated export economy may have found little amiss with competitive authoritarianism, the picture might have been significantly different for other actors. Market reformers expect that the economic and political distortions of the typical postcommunist competitive authoritarian regime will come to outweigh the possible downsides of regime liberalization: macroeconomic fundamentals are likely to be out of line, markets are smaller than they could be; predatory state practices drive capital abroad or into hiding; and an entrepreneur’s failure to deliver political goods to regime patrons can lead to various forms of state expropriation or worse. In short, under political crisis conditions, some economic elites might welcome an opposition promising greater transparency, fairness, and political accountability. Yet this logic will primarily apply to those elites whose firms have the potential to produce a product that will sell profitably on a competitive market without much state intervention. Others have worked hard to build a set of political institutional supports that enable their firms to operate successfully in difficult postcommunist political conditions and are likely to be threatened by the disrupting scrutiny that regime liberalization will bring to these arrangements. Still others are purely rent-seeking and likely to face more dismal and strikingly less profitable futures once their patrons are removed. The remainder of this chapter develops this story with a focus on the politics of reform and crisis in Ukraine from 1991 to 2004. We pay specific attention to the tendency of competitive authoritarian regimes to experience periodic crises and to the strategic logics of entrepreneurs, regime opponents, and the regimes themselves during these crises. We will also attempt to explain one significant anomaly for both theories: why many business elites would back a revolution in a country experiencing 9 to 12 percent growth.

The Political Economy of Ukraine Ukraine’s Captured Regime, 1991–1999

State capture, as defined by Joel Hellman and Daniel Kaufmann, occurs when firms “shape the laws, policies, and regulations of the state to their own advantage by providing illicit private gains to public officials” (2001: 1). As with most former Soviet states, state capture in Ukraine originated in the top-down nature of its transition from communism. Most of the initial postcommunist regimes of Central Europe and the Baltic states emerged from highly mobilized societies that displaced incumbent regimes. By con-

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trast, regime transition in Ukraine was an incumbent elite-engineered affair. After an overwhelming vote for independence in 1991, Ukraine’s dissident movement—based largely in the ethnic Ukrainian region of the country—proved unable to overcome the organizational and regional advantages of incumbents in the resulting founding elections. As a result, founding elections did little to challenge the conservative nature of Ukraine’s break with the USSR. Leonid Kravchuk, the new country’s first elected president, had solid apparatchik credentials. He had not opposed the 1991 hard-line Soviet coup, nor had Kravchuk (then the speaker of the parliament) and the last Sovietera government been forced to the negotiating table by a strong-willed opposition. As a result, incumbents controlled the introduction of competitive forms of government (Havrylshyn 2000: 53; Prizel 2000: 14). The following years would have been tough on any government. Among other challenges, Ukraine faced hyperinflation, a breakdown in intra–Commonwealth of Independent States (CIS) payments, a related catastrophic collapse in trade, and limited and uncertain access to Russian energy imports (Basiuk 2000; Prizel 2000). Yet President Kravchuk and his newly appointed prime minister, Kuchma,6 did little to improve matters. Kuchma’s commitment to economic reforms is the subject of some debate. Detractors argue that Kuchma was unwilling to challenge the interests of his political mentors—drawn from the red directors of the now-defunct command economy. Yet, Kuchma put economic liberal Viktor Pynzenyk in charge of economic policy and supported his efforts to liberalize prices and stabilize the currency. He also resisted cheap credits to state enterprises and collective farms. In May 1993, President Kravchuk openly split with his prime minister over extending the prime minister’s ability to pass key economic reforms by emergency decree. Parliament began to undo the government’s limited reforms over the summer, leading Pynzenyk to resign in July. Kuchma, who now surpassed the president in popularity polls, held on to the premiership until October. He then became head of a trade association representing the managerial interests of state-owned companies. Kravchuk replaced him with Yukhym Zvyahilsky. Manager of a large coal mine in eastern Ukraine, Zvyahilsky reversed a large part of the reforms Kuchma and Pynzenyk had put into place (Havrylyshyn 2000: 56–57). Kuchma chose to run against Kravchuk in the 1994 presidential elections—winning with 52 percent—a victory allegedly made possible, at least in part, by Kuchma’s links to well-heeled entrepreneurs who had become rich through diverse late Soviet–early postcommunist trading schemes (Wilson 2005: 37–38). After a significant reform initiative stalled in 1994–

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1995, Kuchma argued that he would need a stronger presidency to stabilize the economy. After threatening to resort to an extraconstitutional referendum if he did not get his way, parliament agreed to a new constitution in 1996— creating what Paul D’Anieri has called “one of the most powerful presidencies in the world” (2003: 60). The new constitution allowed the president to appoint and dismiss the prime minister and key ministers in the government without parliamentary consent. It also gave him the authority to appoint regional and district administrators (Beichelt and Pavlenko 2005: 57–58). Kuchma’s use of this immense authority was conservative and oriented toward brokering power among Ukraine’s emerging postcommunist elite— often referred to as clans because of their organization along regional and sectoral lines.7 For most of the 1990s these groups clashed bitterly over who would control access to the vast resources of the defunct Soviet state. This goal contradicted the obvious need for reform. While publicly proreform, Kuchma proved irresolute when confronted by strong parliamentary opposition. The most significant opposition bloc came from the communists, who had become dominated by the managers of state enterprises in the 1990 and 1994 parliamentary elections. The communists were strongest in the largely Russian-speaking and industrialized eastern part of the country (party leader Petro Symonenko was from the eastern coal- and steel-producing region of Donbas). The communists had strongly supported the December 1991 referendum on independence, if only to secure their political survival following the failed August coup. Yet they too remained fundamentally conservative. Rhetorically, they hoped to reverse the gradual process of industrial decapitalization that had occurred during the Gorbachev era. Indeed, their public vision of the future lay in revitalizing the sorts of Sovietera industrial and agricultural industries that were being systematically transformed by reformers in Central Europe. But in practice, they sought to maintain rents and patronage derived from control over state-owned enterprises. Economist Anders Åslund and International Monetary Fund (IMF) economist Oleh Havrylyshyn make a strong case that the best explanation for economic stagnation from 1991 to 1999 lay in the power of this “small, homogenous, and omnipotent” cadre of ex-communists who slowed the transition to benefit from various arbitrage and rent-drawing opportunities (Åslund 2000: 263; Havrylyshyn 2000: 50–54; Puglisi 2003: 105; see also Kovaleva 2007: 62–72). In addition to simply controlling access to highly subsidized state enterprises and credits, early scams included buying subsidized metals and chemicals for as little as 10 percent of their value,

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selling them for full price on world markets, and pocketing the difference in an offshore bank account. Given the breakdown of the payments system, many goods were traded to other CIS countries in barter arrangements. By undervaluing the true value of the goods received abroad in these deals, businessmen and state enterprise directors could earn large profits, diverting the unreported earnings to offshore banks (Puglisi 2003: 105; Åslund 2000: 264; Havrylyshyn 2000: 51–52; Karatnycky 2005; Kravchuk 2003: 52). While these scams provided offshore capital that entrepreneurs would later use to drive development, in the short term, the country got too little value for what it sold and bartered abroad. This simply deepened the Ukrainian business sector’s cash and investment crisis. In the inflationary Kravchuk era, moreover, financial elites made fortunes by acquiring subsidized state credits that could be paid back at a fraction of their original worth in hyperinflated rubles. In 1993, for example, the official interest rate was 20 percent while the inflation rate was 10,155 percent. Yet, the state issued credits totaling 47 percent of gross domestic product (GDP). For over two years, the government essentially gave away money to its financial elites (Puglisi 2003: 105).8 While critics have labeled the Ukraine of 1992–1994 the “most economically illiterate nation on earth” (Kravchuk 2003: 49), such insults are misleading. Many if not most of Ukraine’s economic failings were deliberately and knowingly self-inflicted by people who stood to benefit from them. Many of the scams and their beneficiaries were relatively well understood at the time (see Havrylyshyn 2000), yet a dysfunctional political system prevented this knowledge from being put to good use. In short, it would take more than the skill or will of the political elite to turn things around. It is bad political economy to expect self-serving elites to voluntarily give up the practices that enrich them. Change was most likely to come through either self-interest or political coercion. It was self-interest that helped end hyperinflation. In late 1994, printing money to finance deficits was no longer an option and the government adopted a strict IMF stabilization program in exchange for enough money to meet social payments in the lead-up to the presidential election (Kravchuk 2003). In 1995, the government took additional steps to stabilize the economy through sales of government securities. The securities had a fixed face value that would give a negative return under sufficiently inflationary conditions. As Ukraine’s network-dominated, financial-industrial groups switched to loaning the government money, its elites found new incentives to resist inflation. The government and National Bank of Ukraine (NBU) added an additional disciplinary layer by creating a more liquid, decentral-

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ized foreign exchange market in which authorized banks could more easily punish the state for gross fiscal imprudence through capital flight. The new discipline stabilized the monetary supply to the point where the NBU could introduce a new currency, the hryvna, in 1996 (Yushchenko 2000: 96–103; Wilson 2005: 14–15). Yet the government still had difficulties restraining its fiscal policy. Ukraine’s public spending commitments averaged between 10 and 30 percent, which was more than much wealthier European Union countries (Kravchuk 2003: 49). Fiscal indiscipline was exacerbated by Kuchma’s occasional turns to the left and the government’s practice of providing payouts to constituencies in the run-up to elections (Åslund 2000: 264–267; Åslund and de Menil 2000: 7–9; Kravchuk 2003). In addition, the government preyed on itself. Heroic efforts to profit from control of the economy extended to top officials. In 1996, for example, Pavol Lazarenko, the prime minister, restored regulations on the private export of grain—effectively giving him a state monopoly on foreign trade. This allegedly enabled him to siphon off the difference between world market prices and the lower, fixed domestic price (Puglisi 2003: 112–113). Lazarenko’s largest scam, however, was to grant a regional energy distribution monopoly to an energy company he had set up with Yulia Tymoshenko prior to becoming prime minister. This gave them a regional monopoly on distribution and access to subsidized Russian gas imports, which they could then barter or sell at a profit. The company also had a fiveyear tax break as a nominal joint venture. Lazarenko transferred hundreds of millions of dollars abroad before twice fleeing abroad himself—the second time after parliament stripped him of his parliamentary immunity (Wilson 2005: 19, 40). Lazarenko’s commodity dealings—particularly in regional gas distribution—were actually the typical means by which many economic leaders made their fortunes in the 1990s. His downfall came not so much because he scammed the energy and agriculture markets—many elites did this—but because he used his position and profits to openly challenge the power of the president, both in their mutual home region of Dnipropetrovsk and nationally. Perhaps the biggest threat was his new political party, Hromada, which opposed Kuchma in parliament. Kuchma’s survival strategy was to balance the competing regional oligarch interests. Lazarenko threatened this by holding high office and using it to build his own base of power. After his dismissal, it was not until 2002 that business networks would again control a government, but even then, Kuchma ensured that power remained balanced across competing oligarchic groups (Åslund 2006: 17).

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Despite the dismissal of Lazarenko, rent-seeking remained Ukraine’s dominant business strategy until the end of the decade. Most rent-seekers were parts of regional networks with at least two nominal chiefs—one in charge of a group of state or private enterprises, and one located in a senior administration post or parliament. After Lazarenko, networks also sponsored political parties that were little more than the business groups’ rent-seeking vehicles (although the presidential administration also supported or created fake parties to siphon support from political rivals). Many enterprise leaders served in parliament—where, by 2002, the majority had become millionaires. As deputies, they received the added benefit of parliamentary immunity (Åslund 2000, 2006; for details, see Puglisi 2003: 108–109). Progress weaning stakeholders in economic dysfunction from the public trough was slow and noncommittal. A key solution offered by the market reformers was to halt the subsidies, liberalize markets, and, most importantly, privatize enterprises. Market reformers expected private owners to maximize returns on their assets by contracting around inefficiencies rather than seeking to draw rents from them. Yet, given that the beneficiaries of economic dysfunction also controlled the state, such hopes were naïve at best. Indeed, outside of small enterprises privatized for cash, large- and much medium-scale privatization in the 1990s produced neither changes in management and strategies nor new cash for investment (Toms and Korbut 2005: 43). Privatization was thus a reform exception that proved the rule of state capture. One of the first acts of the independent Ukrainian government in December 1991 was to declare the need for a rapid but socially acceptable privatization program. What followed was a broad range of privatization methods that officially sought to balance social concerns and fairness with insider demands for control. From the start, however, insiders had significant advantages in privatization. Even prior to formal privatization, in the late Soviet times, top managers of state-owned enterprises leased enterprise assets to small enterprises and cooperatives in which they generally had a personal interest. These small trading firms also served as wholesalers for the state-owned firms. By overcharging and underpaying the state firm, the interlocking managements of the two companies could privatize the larger state enterprise’s cash flow. In the cash-strapped coal industry, for example, the small enterprises would barter conveyor belts, steel, or other crucial equipment for generous allotments of heating or, preferably, coke coal. As the market value of the coal was generally far greater than the equipment provided, the trading firm would turn a large material surplus. With few exceptions, the ownership of

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the trade firms consisted of bureaucrats from industrial branch ministries or senior management of large state-owned enterprises. Local and regional state officials soon caught on to the scam. But rather than put an end to the drain on state resources, state officials used their power to direct local tax authorities or fire and sanitary inspectors to shake managers down until they provided a share of the flows. Political patronage and protection thus became an important part of the new model of private capital accumulation (Lyakh 2007: 86–87). Ukraine’s modes of privatization form a crucial part of this story. Privatization began, as in Czechoslovakia, with the corporatization of firms in which enterprises would issue stock and transfer it to the State Property Fund (SPF) in preparation for distribution to private owners. Unable, in most cases, to gain controlling shares of this capital outright, Ukraine’s incumbent managers and ministry bureaucrats embraced a privatization framework that dispersed ownership so widely that they would remain in effective control. Twenty-one percent of the SPF assets, according to one IMF sample, were transferred broadly across current and former employees, as well as a few preferential categories of citizens such as World War II heroes, in exchange for privatization certificates—similar to the Czech program—and cash. Managers were eligible to purchase up to 10 percent of additional shares—at inflation-discounted prices—if they completed corporatization of the firm and gave the SPF a clear privatization plan. Enterprise insiders also often augmented their control through commercial tenders in which limited additional shares of the company went to the bidder offering the highest combination of privatization securities and cash (Pivovarsky 2003: 31–32). Mass privatization was slightly more equitable, at least on the surface. In 1992, parliament wanted to be seen addressing a popular concern that average citizens be included in the benefits of privatization. Legislation passed in 1992 was inspired by the Czechoslovak voucher privatization program. Citizens received privatization certificates that they could later exchange for company shares in an auction. After hyperinflation confiscated the savings of many Ukrainians, an additional compensation voucher was issued to the victims that could be used for similar purposes. Unlike the certificates, these vouchers could be traded—offering managers and other investors an opportunity to acquire larger corporate stakes cheaply. Most certificates and vouchers, however, went to privatization trusts or investment companies that then acquired minority positions in enterprises.9 According to one IMF sample, these privatization securities accounted for the transfer of around 25 percent of the equity of medium- to large-scale enterprises (Pivovarsky 2003: 30).10

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Despite the rapid creation of 36,000 joint stock companies in Ukraine, parliament’s managers-turned-politicians had little incentive to pass adequate regulations or create institutions to ensure good corporate governance. The result was predictable disaster for millions of new minority shareholders created through mass privatization. It also discouraged new portfolio investment in all but a small handful or relatively transparently run blue chip companies. Under Ukraine’s applicable 1991 law on joint stock companies, it was arguably legal for controlling managers to strip company assets or make very large transactions without informing the general assembly of shareholders. Worse, minority shareholders could be excluded from supervisory boards and effectively prevented from calling general meetings of shareholders to hold management accountable. In addition to these lacunae in legislation, courts had neither the training nor the resources to enforce the few standards that did exist. Delay and corruption helped ensure that most disputes were settled out of court—providing ample opportunities for mafia and hired security groups to settle accounts—particularly in the late 1990s. No efforts were made to improve the situation until 2002 (IFC 2005: 66–69). In short, despite the nod to social equity, Ukraine’s privatization framework favored insider-dominated programs based on various forms of inexpensive transfer of state assets, generally to incumbent managements (Puglisi 2003: 105; Yekhanurov 2000). Thanks to poor capital markets regulation, residual shareholders rarely received any value from their assets. Furthermore, the wild west atmosphere discouraged foreign investment and encouraged capital flight. Such a state of affairs was decidedly dysfunctional. It was thus with some justification then, that from 1997 to 1999, the government reoriented large-scale privatization around cash sales. Nevertheless, the benefits of these large tenders similarly went disproportionately to domestic business networks at prices that were often a fraction of the enterprises’ real worth. Beneficiaries of these and later privatizations included some of contemporary Europe’s richest men, including Rinat Ahkmetov in Donetsk; estranged onetime Tymoshenko partner and, after 1999, Kuchma’s son-inlaw, Viktor Pinchuk in Dnipropetrovsk; and Kuchma’s chief of staff, Viktor Medvedchuk, in Kyiv. Smaller networks in Kharkiv, Odessa, and Crimea similarly dominated cash sales privatization in those regions. These rival groups competed and colluded fiercely for local advantage and patronage from Kyiv. All parties had their entrepreneurs jockeying for favor with the presidential administration—or winning high office themselves, like Lazarenko in 1997; Medvedchuk in 2002; and Yanukovych, the Donetsk power broker, also in 2002.

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Questions of equity aside, the emergence of more concentrated ownership structures was probably an improvement. A 2003 IMF report showed, perhaps not surprisingly, that concentrated ownership produced better corporate performance than the dispersed ownership emerging from mass privatization. As in the Czech and Slovak republics, mass privatization without adequate institutional backing to enforce minority shareholder rights provided incentives for asset abuse rather than restructuring. Secure owners, by contrast, were more likely to reinvest profits and raise productivity, introduce new technology, and replace ineffective management teams. Concentrated foreign ownership typically produced the best results of all, yet preference in Ukraine was generally given to national capital (Pivovarsky 2003: 38–39). The 1998 Russian financial crisis was a wake-up call for Ukraine’s political and economic elite. Most elites probably realized that the existing system of economic management was unsustainable, but diverse factions in the regions, parliament, and the presidential administration competitively sought to ensure the pain of adjustment would come at the expense of someone else’s rents. Questions about the ability of the government to meet its debt obligations led to a significant crisis of investor confidence. Only deft financial management by Viktor Yushchenko in the NBU prevented a complete default in 1999. This included matching Russian devaluation, currency controls, forcibly converting government securities held by foreigners into more manageable Eurobonds, and some highly creative accounting to mislead international lenders about the true state of Ukraine’s foreign currency reserves. By the time of the 1999 presidential election, the macroeconomy was on a firmer footing, but still fragile. Default on government obligations to debt holders remained a distinct possibility (Åslund 2009: 131; de Menil 2000). The Yushchenko Interlude, 1999–2001

Kuchma appointed Yushchenko as Ukraine’s prime minister in December 1999. As chairman of the NBU since 1993, Yushchenko had won international respect for a clean image, his consistent support for liberal reforms, and promoting a culture of sound monetary management (Karatnycky 2005). Anders Åslund asserts that Ukraine’s economic elite prompted Yushchenko’s appointment out of a desire to restore Ukraine’s creditworthiness in the wake of Russia’s 1998 financial crisis. Fiscal reform would help ensure that the government would have the resources to pay back the money that financial groups had loaned them since the stabilization of the currency and prevent the sort of financial meltdown that had so sorely hurt

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Russia’s oligarchs in the 1998 crisis (2005: 328). Yet pressure from Washington also apparently played a role (Wilson 2005: 44–45). Yushchenko won a free hand in naming his cabinet. Among other reformers, he took on Tymoshenko as deputy prime minister for energy. Andrew Wilson remarks that as a former energy executive herself, she had unique insight into the diverse scams that plagued Ukrainians (2005: 46). In the face of fierce parliamentary resistance, Yushchenko and Tymoshenko eliminated the most egregious forms of rent-seeking and vastly improved fiscal management. This included forcing payments to be made in money rather than barter, and abolishing over 270 subsidies, tax breaks, and directed licenses that provided oligarchs their enormous and costly economic privileges. The government also cut red tape on entrepreneurs, eliminated collective farms, and moved the country toward a tax reform that would eventually encourage businessmen to emerge from a shadow economy. Government efforts netted the Ukrainian budget an estimated $4 billion (Wilson 2005: 48). Short on cash due to continued IMF refusal to loan the government new credits, Yushchenko angered some domestic businessmen by selling shares of leading oil refineries to Russian investors for reasonably competitive prices (Wilson 2005: 46). By the end of 2000, the government had turned a 1.5 percent budget deficit into a 0.6 percent surplus while paying down substantial levels of foreign debt (Evans 2001: 5). With the money saved, the government paid wage and pension arrears. Where these reforms remained in place, they fundamentally altered the opportunity structure faced by Ukraine’s business community. According to Åslund, the changes forced many businesses to move from commodity arbitrage schemes to actually producing things that might sell on the market (2006: 14). The battle against politically procured rents was by no means over; however, as most large-scale privatization had yet to occur, control over the levers of public policy became more important than ever. Yushchenko and Tymoshenko’s reform crusade faltered when they attempted to take on powerful coal and steel interests in eastern Ukraine’s highly developed industrial heartland. Control of the coal sector lay in the various Donetsk and Dnipropetrovsk networks, where it was inseparable from the interests of the steel industry. Most of the big steel players were based in Donetsk—the dominant actors being the Industrial Union of Donbas (IDS) and Akhmetov’s Systems Capital Management (SCM). As well, Ihor Kolomoyskiy’s Privat Group/Privatbank and later Pinchuk’s Interpipe were significant players. Both were based in Dnipropetrovsk. While Ukraine’s steel sector played an important role in driving an

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economic recovery from the disastrous 1990s, its profits were exaggerated through a state-brokered, advantageous relationship with the coal sector. First, in the 1990s the main steel networks loaned undercapitalized mines money to purchase mining equipment at exorbitant prices. When the mines could not repay, steel industry creditors forced them to choose between creditor-initiated bankruptcy and selling them coal at preferential prices. Through such pressure, the steel sector was often able to choose pliant managers for state-owned coal mines, whom they could then manipulate to ensure favorable coal prices and other perks (Pleines 2004: 17). Donetsk interests also controlled the Ministry of Fuel and Energy, which they used to ensure sympathetic management teams in state-owned coal mines and set low coal prices.11 Unable to generate a profit due to low coal and coke prices, the coal sector was kept alive through $2 billion in government subsidies. The state provided the money to keep unprofitable mines open and militant coal miners quiet (although see Kubicek 2004: 158–180). Political concerns were also paramount: a credible effort to restructure the sector would have led to mine closures and tens of thousands of new unemployed. Subsidies kept these people at work, but they also provided Donetsk-controlled electricity generating companies with cheap heating coal inputs. Cheap energy, in turn, further fattened the steel mills’ bottom line in the export market (Bogatov 2007: 138). To add to the irony, unable to turn a profit, the coal industry paid virtually no government taxes (Pleines 2004: 17; Egorov 2003: 34–35; Von Hirschhausen and Vincentz 2000: 174–175). Not surprisingly, beyond privatizing the few profitable mines producing high-quality, hard, coking coal essential to steel production, the powerful Dnipropetrovsk and Donetsk networks resisted any rationalization of the coal sector and took deep offense at Tymoshenko’s efforts to do so. While Tymoshenko’s reforms raised overall coal production and investment and almost halved the percentage of firms refusing to pay taxes (Egorov 2003: 36–37), the basic structure of the industry survived the reform era intact. Subsidies even increased (Pleines 2004: 29). At the heart of the conflict between the eastern networks and the reform government was a broader competition over rival modes of capitalism. Eastern interests could credibly argue that closing coal mines and allowing Russian and other foreign industrialists to outbid domestic capitalists for lucrative economic assets would disrupt the systems of regional social stability and lead to capital drain. It would also undermine an increasingly successful model of regional capital accumulation. As scholars Adam Swain and Vlad Mykhnenko write:

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[I]s it so bad that steel plants in Donbas have been able to compete on international markets and earn significant export profits which have been recycled around the region? Would it have been better if crude economic logic had resulted in the closure of more mines and some steel works with the resultant increases in poverty, energy insecurity and reduced competition for foreign steel companies? . . . That the Donbases’ family silver has been reserved for locals may be a source of annoyance to predatory western companies supported by their sponsors in western governments and international financial institutions, but it is hardly a crime and might even be a cause for celebration. (2007: 41)

It is also important to note that much of Yushchenko’s support came from the country’s poorly performing, state-dependent, western agricultural sector. Ironically, agricultural interests did not so much want to dismantle the state-coordinated market economy as to be included more explicitly in its benefits. To a certain extent, these groups were as conservative and antireform as the dominant industrial business networks to the east. This allegedly provided an incentive for economic populism and fiscal irresponsibility that muddied economic policy following the Orange Revolution (Mykhnenko 2009). Despite eastern resistance, Yushchenko’s reforms made him Ukraine’s most popular politician, with an approval rating of 52 percent (Karatnycky 2005). Yet, the program angered the former beneficiaries of economic dysfunction. Analyst Nadia Duik argues that by 2001, anger at reforms united four of the five major factions in the parliament and even succeeded in uniting the communists with representatives of the energy sector in parliament (2001: 61–62; Egorov 2003: 38). Under pressure from regional elite networks, embroiled in a deep scandal surrounding the murder of journalist Heorhiy Gongadze (see below), and fearing his prime minister’s growing popularity and political ambitions, Kuchma put a halt to the rapid liberal reform era.12 First, he organized the dismissal and arrest on corruption charges of Tymoshenko—she was soon released13—and second, he supported a vote of no confidence against Yushchenko in May 2001. Kuchma replaced him with a communist-era industrialist, Anatolii Kinakh, whose main accomplishment was to leave Yushchenko’s reforms in place. The Presidential System

While Ukraine’s business class could agree on their opposition to Yushchenko’s reforms, politics at the top remained feisty and competitive. In Dnipropetrovsk, Pinchuk faced challenges from rival Privat Group. Akhmetov had local competition in Donetsk from the IDS, although they more often collaborated, and Transcarpatia/Kyiv’s Medvedchuk regarded Donetsk interests with suspicion (for more on the regional networks, their

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holdings, and rivalries, see Åslund 2006: 17–20; Swain and Mykhnenko 2007; Wilson 2005: 40–42). With his reelection as president in 1999, Kuchma made himself the pivot point of this jockeying. Regional business networks exchanged support for Kuchma’s government for a freer hand in the regions (Swain and Mykhnenko 2007: 39). This led one observer to identify the “consolidation” of the “oligarchic system” by 1999, in which “the president’s patronage network set relations between political power and business on new foundations.” “[C]loseness to the president” had become an important part of any business plan (Puglisi 2003: 111). Through their assorted political and business arrangements, trade companies and their associated firms spawned expanding networks of firms known as financial industrial groups (FIGs) that subsequently helped drive development in Ukraine. Indeed, while much money flowed from the trading firms to offshore bank accounts in the 1990s, between 1999 and 2004, FIGs often repatriated money for industrial development and reconstruction. Offshore banks in countries such as the British Virgin Islands and Cyprus thus provided a leading source of foreign direct investment in Ukraine (Lyakh 2007: 91; Motyl 2005). As the fate of the Yushchenko government demonstrated, the new business-political elite had little interest in the sorts of economic or political reforms that might disrupt their particular mode of accumulating resources. Nor did they wish to face significant competition from foreign capital. Illiberal government shielded the nature of business-government relations from the scrutiny of rivals and voters. More importantly, it enabled insider elites to retain a high level of information asymmetry between themselves and ordinary citizens. The elites could thus continue benefiting, often at society’s expense (Vachudova 2005: 16–17). Many had a distinct incentive to keep society weak and politics illiberal. This helped ensure that the benefits of development, where it did occur, would disproportionately flow to the emergent networks. This was not entirely bad. Much of this capital would then be recycled in the local economy. As export markets recovered after 2000 following Yushchenko’s reforms, this model of state-coordinated national capitalism was at the heart of a robust recovery from the dismal 1990s, producing explosions of development in the regional capitals of Donetsk and Dnipropetrovsk, as well as Kyiv. But the extreme politicization of the economy also became increasingly resented by those excluded from its benefits, most notably the less prosperous agricultural regions in the west and the poorer regions’ many small and medium-sized businesses. These regions lacked the dynamism and capital of the east. The result was that Ukraine’s growing economic

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divide reinforced its cultural-identity divide. The exception was the wealthy, primarily Russian-speaking capital of Kyiv. In the increasingly wealthy, Russian-speaking east, however, entrepreneurs, from publicly proclaimed oligarchs down to restaurant owners, tended to support the government (Mykhnenko 2009). Ukraine’s regional industrial chiefs took about a year to consolidate their control over economic policy. Kyiv-based oligarch Medvedchuk became chief of the presidential administration in June 2002—followed by the appointment of the Donetsk networks’ house politician, Yanukovych, as prime minister in November 2002 following contested elections. Yanukovych wasted little time putting IDS cofounder Vitaly Hayduk in charge of the energy sector—Tymoshenko’s former position. Hayduk and his Donetsk-based successors halted coal sector reform and even increased coal sector subsidies—a measure that continued to fatten steel profits (Pleines 2004: 25). The new powers also wasted little time in privatizing key industrial assets to Donetsk firms at a fraction of their true worth (Wilson 2005: 50). Yet they also made some crucial business-friendly reforms—most notably introducing a 13 percent flat income tax, lowering corporate and Value Added taxes, and easing formal impediments to setting up and operating businesses (Åslund 2009: 161). Kuchma’s power base lay in Dnipropetrovsk, but his appointments balanced the competing regional interests of Medvedchuk in Kyiv, with Akhmetov and others in Donetsk. Still, Medvedchuk felt threatened by Donetsk’s growing influence. As the prime minister opened some of Kyiv’s rich business opportunities to the Donetsk network, the rivalry intensified. By 2003, Medvedchuk was using the Security Service of Ukraine to embarrass the prime minister’s diplomatic initiatives in the West.14 He also employed a barrage of tax inspectors, health inspectors, and fire inspectors to subject Donetsk interests to petty harassment. Meanwhile, Akhmetov and Pinchuk combined efforts to privatize the Kryvorizhstal steel mill in 2004. Despite producing 20 percent of Ukraine’s steel output, they bought the plant for only one-sixth of its eventual 2005 market price (EBRD 2005: 194). This was made possible by formal tender conditions that eliminated foreign and some domestic rivals’ offering up to three times as much (Kapucinsky 2005). Ukraine’s Robust Growth

The brazen giveaway of Kryvorizhstal at the height of the 2004 presidential campaign shows the confidence Kuchma’s supporters had in their ability to “manage” democracy in the fall 2004 elections. The 1999–2004 period

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provided little warning otherwise. The devastating 1990s were dominated by an elite scramble over the resources of the country. In a classic prisoner’s dilemma, few restrained themselves, knowing that if they did not seize the opportunity to loot the country, someone else would. As noted by Rosario Puglisi, the consolidation of presidential power after the 1999 elections helped solve the Ukrainian elites’ seemingly endless collective action problem (2003). Henceforth, the answer to the country’s most difficult distributional dilemmas came through more predictable—if informal—channels. While corruption and rent-seeking persisted, greater political certainty led to more investor confidence. With the often deadly turf battles of the 1990s more or less settled, entrepreneurs could rely on informal and formal rules of property protection and contract enforcement.15 Yushchenko’s liberalization of the entrepreneurial environment also made entrepreneurialism safer and less costly—leading to the formalization of part of the informal economy.16 Foreign investment—mostly repatriated Ukrainian capital from havens like the Caymans and British Virgin Islands—boomed. The emergence of a well-defined party of power clearly in charge of the benefits of policies permitted the government to take large-scale privatization seriously—if only to keep Kuchma’s competing supporters in line. From 2002 to 2004, Ukraine’s most valuable assets were sold to Kuchma supporters for a fraction of their real worth in processes that lacked transparency and often excluded higher-paying foreign and domestic rivals. Even so, the sales added billions of dollars to the budget—helping the government to meet its large social obligations. Privatization revenues started out at 2.9 percent of GDP in 1999, rose to 6 percent of GDP in 2002, and reached 9.5 percent of GDP in 2004 (EBRD 2005). Ukraine also benefitted from an international windfall in global trade. Thanks to Yushchenko’s agricultural reforms, agribusiness was also in a slightly better position to profit from rapidly rising Russian demand. Yet the main driver of growth was a boom in international demand for steel and industrial commodities. Exports surged 26 percent in 2003, and steel made up about 40 percent of this (Wilson 2005: 12). Supporters of the Donbas region’s model of economic development pointed out that domestic ownership ensured that profits were recycled locally—further driving growth—rather than expatriated to the pockets of foreign owners (Swain and Mykhnenko 2007: 41). Yet industry subsidies did not escape the scrutiny of EU and US regulators, who repeatedly levied accusations of dumping and sought to limit imports. While growth was undeniable, scams may also have exaggerated the official growth figures—although by how much is hard to estimate.17 The

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record export numbers were at least partly the result of fictitious shipments made to collect a refund of the Value Added Tax (VAT).18 According to one IMF official, millions of hryvna were paid out for nonexistent exports every year.19 Ukrainian journalist Volodymyr Martenyuk provides the details: [A] friend . . . used to create fake exports to collect the VAT. He would load up a barge with grain and ceremoniously make it look like it was leaving the port, with customs agents affixing all the correct stamps signifying that a certain amount of Ukrainian grain had been exported. The barge would then turn around and return to a different dock in the same port. This happened about two times a month. . . . My friend’s firm would then turn to the government and collect the tax money “owed to it”—in this way making money from air. The government certainly knew about such practices and would often refuse to make these payments, many times to people who were genuinely involved in exporting goods. However, this friend had some connections in the government and, for a fee of twenty to thirty percent, they would help him collect the money—in the millions of dollars.20

Similarly, to avoid paying the full amount in import tariffs and customs duties, many businessmen and companies would allegedly bribe officials to undervalue foreign goods.21 Entrepreneur Vyacheslav Rushchyshyn asserts that his “competitors—those ‘with connections in Kyiv’—received shipments of Chinese-made suits virtually duty-free by declaring their value to be a ludicrous seventeen cents apiece” (Meier 2006: 45). Given the profitability of illegal cross-border trade, positions in the border guards were highly coveted. According to one high-ranking official in the border guards, it cost an $8,000 bribe to get into the Border Guards Academy, while the position of director at a border crossing went for as much as $150,000.22 Not surprisingly, Poland’s official 2003 statistics recorded $800 million more in exports to Ukraine than appeared in Ukrainian statistics.23 Yet, Poland was only Ukraine’s fourth largest trade partner. Fake, overvalued exports, combined with undervalued imports, put a strain on the governmental budget and possibly exaggerated Ukraine’s economic growth by billions of dollars. Kuchma’s Competitive Authoritarian Regime

The final years of the Kuchma administration put Ukraine’s embattled liberal institutions under extreme stress. In October 2004, the government attempted an authoritarian falsification of the presidential elections, but, arguably, the regime had already stepped onto the threshold of authoritarianism. The

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inherent and inevitable contradiction between liberal political freedom and politically entrenched rent-seeking meant that one had to give—a classic competitive authoritarian dilemma. For most of the Kuchma era, liberal principle and institutions—and those who relied on them—took a beating.24 Yet, the administration was both unwilling and unable to fully suppress its opponents. From 2000 to 2004, regime opponents took advantage of their limited space for political action to create no less than three increasingly significant regime crises (Wilson 2005). The first came in 2000 following the release of security officer Mykola Melnychenko, who was held for the secretly recorded tapes he had of the president’s meetings with subordinates.25 Nevertheless, the regime infiltrated the opposition movement with agents provocateurs to create the violence necessary to justify discrediting and suppressing the movement. Failure in 2000–2001 led to a more significant opposition challenge in the 2002 parliamentary elections. Recently dismissed from office, Yushchenko formed a popular new party, Our Ukraine.26 The threat to Kuchma’s political power was very real. Yushchenko arguably could take credit for the rebounding economy and was already seen as a credible opposition candidate for the 2004 presidential election. The Melnychenko tapes also gave Ukrainians new insights into the nature of their leadership. Ukrainians—particularly those in central and western Ukraine—voted heavily for the new party and other opposition party lists. Yet, in March 2002, the opposition was unable fully to capitalize on voter dissatisfaction. Yushchenko, the communists, and other key opposition parties could not overcome ideological and personal animosities to unite against Kuchma’s party of power (For a United Ukraine). In addition, despite winning a plurality of the vote, Our Ukraine suffered from the state’s administrative advantages. These included voter coercion and intimidation, well-funded fake parties, candidate cloning, and occasional fraud in key districts (Diuk and Gongadze 2002: 161).27 The decisive measure, however, was the state administration’s use of local regulatory officials to intimidate nominally oppositional candidates elected in single-member districts into supporting the party of power in parliament. Most of the targets were businessmen aligned with Yushchenko on the Our Ukraine and other opposition lists. As state raids and inspections disrupted operations and led to fines and closures, some of Yushchenko’s most supportive businessmen lost significant revenues. Others received lucrative bribe offers, although most were too wealthy to bribe. While some stood fast, many switched sides—either out of short-term opportunism or simply to save their livelihoods (Wilson 2005: 68). By late spring, Kuchma’s For a United Ukraine had contrived to build a ruling

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parliamentary coalition out of what had essentially been a voter rebuke (D’Anieri 2007: 93–95). Throughout, Kuchma could count on a subservient broadcast media. In a country where 75 percent of the population gets its news from television, the president’s oligarchs directly or indirectly controlled the six main TV stations.28 By 2004, the opposition did control one channel, Channel 5, but its broadcast area was limited (see Way 2005: 2). Print media, although much more diverse, were also affected. In early 2002, Medvedchuk’s presidential administration began to issue anonymous daily bulletins, or temnyki, to most media organizations detailing which stories to cover and how to present them. Where media were uncooperative, subservient bureaucrats found numerous means to shut them down, including the selective enforcement of building and fire codes, the tax law, and blocking the distribution channels for opposition newspapers (D’Anieri 2003: 61).29 To further control the dissemination of information, the state allegedly resorted to violent intimidation and even to the murder of opposition journalists like Gongadze or Ihor Aleksandrov (Diuk and Gongadze 2002: 165). Radio stations received similar treatment. In the run-up to the 2004 election, three stations broadcasting the US-funded Radio Liberty were effectively silenced—one by the apparent murder of the station director (Åslund 2009: 178). Murder of political opponents is similarly suspected to have been a latent tool of political control. Many understood the 1998 murder of Yushchenko’s protégé Vadym Hetman30 to be a clear warning to the popular banker not to stand for the 1999 presidential election. An at least suspicious automobile accident also killed Vyachislav Chornovil, a Sovietera dissident and another potential Kuchma rival in the 1999 presidential election (Wilson 2005: 43). Tymoshenko, leader of the opposition party, Block of Yulia Tymoshenko, almost died in a mysterious car accident just prior to the 2002 elections. Soon afterwards, a leading member of Our Ukraine died following a baffling illness, as did a witness to the murder of the journalist Aleksandrov. Most notoriously, in the 2004 presidential campaign, Yushchenko survived at least one serious attempt on his life and several other bungled affairs (Diuk and Gongadze 2002: 165; Kuzio 2005: 498). A Business-Driven Revolution?

The Gongadze scandal, the 2002 elections, and other aspects of the competitive authoritarian regime helped mobilize and eventually unify

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Kuchma’s political opponents against his handpicked presidential successor, Yanukovych, the prime minister. Yet, as embarrassing as the regime was for many Ukrainians, entrepreneurs in Kyiv’s small and medium-sized business community found Ukrainian officialdom’s predatory and bullying behaviors to be the greatest irritant. They felt that the growing economy primarily benefited large politically connected producers. Small and medium-sized entrepreneurs in Kyiv were certainly better off with growth. Many had never had it better. But they still had to contend with a system rigged against them. Among other things they faced credit markets tightened by preferred lending to large businesses; inadequate minority shareholder protection; corrupted courts;31 monopolized markets; and perhaps most important to entrepreneurs, a highly politicized, predatory regulatory regime.32 Without political protection—often purchased following shakedowns from local officials—it was difficult to get by. The result was to suppress investment (Karatnycky 2006: 38).33 Yushchenko’s Our Ukraine was thus at least tacitly supported by a large proportion of Ukraine’s small and medium-sized businesses (Åslund asserts a majority, 2006: 19; but see also Mykhnenko 2009). These were also allegedly the sentiments of mainly Kyiv-based millionaires, who tied their economic futures closely to Yushchenko. Most notable among these was David Zhvania, who reached deep into his pockets during the Orange Revolution to fund the logistics and infrastructure of the protest on Kyiv’s Independence Square (Maidan Nezalezhnosti). The only open supporter who resembled an oligarch was Petro Poroshenko—Ukraine’s leading chocolate producer, ship and car builder, and, most importantly, owner of the cable television station TV 5. Other supporters included millionaire race-car driver turned Lvov-based trucking magnate and drinks producer Yevhen Chervonenko,34 power magnate Mykola Martynenko, and Our Ukraine financier Oleksander Morozov. Yushchenko’s campaign chair, Zhvania, asserts that the campaign and subsequent protests cost over $150 million. By contrast, the Yanukovych camp is rumored to have spent as much as $600 million (Åslund 2009: 178, 180). As economist Volodymyr Sidenko of the Razumkov Centre pointed out in 2003, Our Ukraine’s business supporters “represent the newly born business sectors which require a more civilized business environment.”35 Wilson adds that none of these entrepreneurs made their money from the sorts of cash cows that preyed on control of state resources or administratively acquired monopolies. Indeed, “nearly all ran active businesses, which would benefit from a less active state” (Wilson 2005: 62–63). Yet, as the 2002 parliamentary elections demonstrated, supporting Our Ukraine was a costly business strategy. Some could not withstand the

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pressure and defected to the administration. Others attempted to remain neutral (Wilson 2005: 68). Yushchenko thus had an incentive to moderate his opposition to remain attractive to those on the fence. In the political arena, a combination of his rule-of-law message and pure opportunism helped attract a number of turncoats from the party of power.36 Yushchenko drew his two successive campaign managers, Roman Bezsmertnyi and Oleksandr Zinchenko, from among former regime supporters. The latter headed the parliamentary faction of Medvedchuk’s political party, the Social Democratic Party of Ukraine (SDPU), until he switched allegiances in 2003. After switching, he complained of intense political pressure to run businesses specifically to serve party interests. More broadly, he and Kuchma oligarch Pinchuk made headlines in 2003 by calling for the “gentrification” of business and a divorce of economics from politics.37 Yushchenko made the switch easier by promising not to reopen the more distant privatization deals of the 1990s, when many of the Soviet era’s manufacturing enterprises had been acquired by their managers. The worst that entrepreneurs would face would be a onetime privatization surcharge to recover some of the money lost when the companies were sold so cheaply (Kuzio 2009). Such moderation may have enabled the chairman of the Party of Industrialists and Entrepreneurs (PIE), Kinakh, to cross lines in the second round of the 2004 election. Many of PIE’s members were the owners of Soviet-era branch industries and at least some must have been forced by the 1999–2001 reform era to begin to restructure their enterprises toward market competitiveness. While some PIE members remained with the administration, those that followed Kinakh may have been attracted to Yushchenko’s promise to build a more restrained state and relieved by his reassurance on privatization (Åslund 2006; Kuzio 2006: 64). Yushchenko’s Russian privatizations as prime minister also helped win him the at least passive support of Russian tycoons such as Oleg Deripaska (Basic Element), Mikhail Fridman (Alpha Group), Viktor Vekselberg (TNKBP), and Vagit Alekperov (Lukoil) (Wilson 2005: 71, 118). Vladimir Putin’s decision to weigh in heavily on the side of Yanukovych during the 2004 election denied Yushchenko the open support of these Russian oligarchs, but his ability to attract unlikely supporters reflected his centrist instincts during the 2004 campaign. From small and medium-sized entrepreneurs to important foreign investors, Yushchenko symbolized the promise of normalcy: the rule of law rather than a revolution. This helped him survive a public relations campaign attempting to depict him as a radical, divisive nationalist. In this, the presence of the turncoats, businessmen, and Yushchenko’s established centrist political credentials was crucial. They sent a message to Kuchma’s

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oligarchs: beyond some singular high-profile reprivatizations and a demand they play by the rules, a Yushchenko regime would not be devastating to their key interests. This strategy had its limits, however. As Mykhnenko has demonstrated, the country’s heaviest concentration of entrepreneurs, industrialists, merchants, and self-employed professionals was actually in the more industrialized eastern regions of the country—most notably Donetsk and Dnipropetrovsk. These were precisely those areas that unambiguously rejected Yushchenko’s candidacy (2009: 290–291). One should be cautious, therefore, in reducing the 2004 elections to a battle between politically excluded millionaires and politically incorporated billionaires. Evidence seems to indicate that most of the medium-sized and small entrepreneurial class in the east publicly supported Ukraine’s existing capitalist model—particularly in the Donbas region where there is an extraordinarily strong local sense of identity that may serve to bind entrepreneurs to a broader collective agenda (Osipian and Osipian 2006). A less kind interpretation is that the east’s small and medium-sized businessmen were simply acting conservatively under illiberal conditions—fearing expropriation if they worked openly for liberal reforms. Yet, in the case of Donbas, the initial evidence does not support it (Osipian and Osipian 2006; Mykhnenko 2009). Tymoshenko’s role in the Orange Revolution is also interesting. Although an easterner herself, Tymoshenko’s message drew supporters from various factions of the Ukrainian nationalist movement. More rural and prone to paternalist and populist worldviews, these groups belie the image of the Orange Revolution as a strictly liberal capitalist revolt against Kuchma’s heavy industry–dominated coordinated capitalism. As noted earlier, far from liberalizing the economy, many of these interests allegedly wanted state coordination and transfer payments to be more directly focused on their needs and interests (Mykhnenko 2009). Yushchenko wisely downplayed identity and paternal-populism in his campaign, however, focusing more on questions of political fairness, accountability, and the rule of law. This message helped him carry the majority of Russian-speaking communities in Kyiv and central Ukraine. Tymoshenko, by contrast, played bad cop to Yushchenko’s good cop. At the height of the 2004 protests, when hundreds of thousands of people occupied Kyiv’s Independence Square demanding a free and fair vote, Yushchenko gave weight to Tymoshenko’s rhetoric by asserting that he was powerless to get the crowds to leave the square even if he wanted to. By spicing Yushchenko’s pragmatic moderation with a threat of chaos, Tymoshenko helped Yushchenko capture the elite political center and split the administration and its supporters. Indeed, it was Kuchma’s oligarchs, not

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the diverse interests on the Maidan, that failed to show unity during the Orange Revolution. While not openly following Kinakh across the barricades, Kuchma’s oligarchs were remarkably mild in their defense of the regime. After November 25, Pinchuk instructed his television station, ICTV, to cover the opposition in the Maidan (Prytula 2006: 119). A day later, Pinchuk’s political vehicle, Labor Ukraine, broke with Yanukovych’s Party of Regions by failing to oppose a series of compromise resolutions in parliament—the resolutions all passed.38 In a final, decisive exercise of moderation, Yushchenko acquiesced to a compromise change weakening the president’s future constitutional powers.39 This gave Kuchma’s diverse, competing supporters the courage they needed to submit their political and economic futures to the uncertain outcome of the democratic process. On December 8, 2004, all sides agreed to a third election round and to provisions to ensure that it would genuinely be free and fair (Wilson 2005: 149). Virtually everyone at the table correctly expected that this would transfer power to Yushchenko. The Orange Revolution was driven by the indefatigable and resolutely peaceful demand of hundreds of thousands of Ukrainians for a fair and free election. Yet the movement also succeeded because these protestors had the necessary financial and material support to maintain the protests. Some support did come from foreign aid NGOs to local democracy-building NGOs, particularly the Serbian-inspired youth movement, Pora (although see Herd 2005: 12–14; Wilson 2005: 183–190; Zunes 2008, 2005), but most of the resources of the Orange Revolution were local. Primary contributors included Our Ukraine businessman Zhvania, who had learned from the earlier dress rehearsals about the need to have the logistics of the protest well planned in advance. Another important local businessman, Valerii Borovyk, financed Pora (Wilson 2005: 188). Even so, the sheer number of protestors soon overwhelmed the ample stock of tents, mattresses, bio-toilets, food, and transportation that Zhvania had put aside in advance. Kyiv’s small and medium-sized businesses joined average Ukrainians in “thousands of acts of individual kindness” to fill the gap (Wilson 2005: 126). Leonid Finkelstein, coowner of Fakt publications, recalls: Many businesses, such as mine, did help with what they could. There are only fifteen workers here, but we allowed anyone that wanted to stand on the Maidan (square) and still receive full pay. We also paid for food, set up some tents, gave out cigarettes, and gave people rides from the outskirts into the city.40

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Valentin Zagaria, the legal director of a large private equity firm, was typical in his support: “When people would call me about doing work for them, I would simply apologize and explain that I was on the Maidan and couldn’t do any work until [the Revolution] was done. The Orange Revolution was a tremendous opportunity for Ukraine to make a gigantic leap toward a better future.”41 Yuri Chuikov, the CEO of one of the largest mobile phone networks in Ukraine, also devoted resources to keep the Orange Revolution alive and joined thousands of Ukrainians in spending the cold winter nights of 2004 on the square.42 The Orange Revolution was the political coming-of-age of Kyiv’s middle class and businessmen. As one Kyiv-based entrepreneur and Our Ukraine activist recalled, “I was protesting against a Yanukovych victory. . . . With him and his supporters at the top benefiting by abusing and extorting money from everyone below them.”43 According to Ukrainian political scientist Olekciy Koshel, “abuse” from the government served as the “big motivation” for the small and medium-sized businesses that supported the revolution. More broadly, he saw this as a middle-class revolution. “The middle class essentially financed and provided the backbone for the revolution by providing demonstrators with food, housing, clothing, and transportation.”44 Martenyuk, chief editor of the opposition newspaper Schlax Peremogu, echoed this, as did television producer Anatoly Yerema: “Small businesses . . . felt ignored and persecuted. . . . This served as a large incentive for them to join the demonstrations on the Maidan and to help in any way possible.”45 The success of Kyiv’s business efforts was visible within days of the rigged first round of elections. Pro-Yushchenko demonstrators arrived in Kyiv to find a military-like organization. One could receive a hot meal several times per day, use a referral system to find housing for the night, and there was even a location reserved for charging mobile phones. From tents, in which hundreds of thousands of protestors spent nights in the Maidan, to food, warm clothing, portable heaters, and even toiletries, the revolution demanded many resources. While many businesses sought to use the revolution to rebuke a model of capitalism that they felt excluded them from its benefits, in Ukraine’s eastern, Russian-speaking industrial centers, Yanukovych apparently retained the loyalty of the business class (Mykhnenko 2009), who saw the Orange Revolution victory as nothing less than a coup. The location of entrepreneurs on both sides of the struggle suggests that we should be cautious about portraying this as a revolt of economic agents against rent-

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seeking and the predatory state. Rather the preferences of economic elites appear to have reflected a range of issues, including a strong sense of regional identity and the dominant sources of capital accumulation in their communities. Aftermath

The years following the Orange Revolution have assuredly been disappointing for many, if not most, Ukrainians. The Orange Revolution’s promise to build a rule-governed, liberal democracy collapsed into deep elite infighting and a prolonged constitutional crisis. From the start, the good cop/bad cop strategy that effectively put the Kuchma regime on its heels quickly devolved into a bitter interelite contest over how best to deal with Kuchma’s legacy. Tymoshenko became Yushchenko’s first prime minister and set about attacking some of the key interests of the oligarchs and further reducing rent-seeking scams. She rewarded Pinchuk for his November 2004 moderation with the seizure and resale of his Kryvorizhstal steel mill. Pinchuk’s claims to be “Ukraine’s Mikhail Khordokovsky” were drowned out by celebrations over the mill’s $4.8 billion resale price—six times its first sale value.46 Regional business networks were also particularly angered by her surprise decision to limit preferential tax treatment in Special Economic Zones (EBRD 2005: 204). Indeed, her policies directly attacked some of the foundations of Kuchma-era capitalism. Given Tymoshenko’s promise to renationalize the oligarchs’ assets extensively, the oligarchs understandably kept their money in havens abroad. An increase in foreign portfolio and direct investment helped compensate, however. Thus, while foreign direct and portfolio investment from the United States, Western Europe, and Russia grew at the beginning of 2005, investment from Ukrainian offshore havens like Cyprus and the Virgin Islands plummeted.47 This led to a greater role in foreign finance in the economy. Dollar- and euro-denominated borrowing initially provided a welcome source of new capital for businesses. But it also exposed the country to capital flight, devaluation, and potential bankruptcy when the global financial crisis hit in 2008. This has subsequently led some to compare Kuchma-era modes of capital accumulation favorably with the more open regime of the 2005–2009 period (Mykhnenko 2009; Mykhnenko and Swain 2010). Tymoshenko also went after open scams. She eliminated the old practice of collecting fake VAT payments by reducing the types of activities eligible for a VAT refund. She introduced customs raids—teams of agents that, among other things, set up surprise roadblocks to inspect customs declarations in passing cars and trucks.48 Partially as a result of the reduction

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of import and export scams and partially as a result of increased access to foreign capital, exports decreased by a full 10 percent of 2005 GDP while imports grew by 14 percent.49 More broadly, however, Tymoshenko’s brief fight against corruption had mixed results. Many accused both Tymoshenko and Yushchenko of being serious about fighting the corruption of their opponents only as a means of eliminating the old order and replacing it with their own—most of the Orange Revolution’s high-profile business supporters ended up holding high office. Nevertheless, in 2005, 1,350 government officials were prosecuted for violating Ukrainian laws.50 The new regime also took steps to replace most of the top governmental officials left over from the Kuchma regime. According to official sources, around 18,000 civil servants in the public administration were dismissed in 2005 (EBRD 2005: 204). While Tymoshenko took some high-profile steps toward eliminating corruption and dislodging the preferential hold Ukraine’s eastern business networks had over policy, she also catered to the populist demands of Ukraine’s less developed western regions, leading some commentators to quip that the Orange Revolution had a more socialist than capitalist flavor (Mykhnenko 2009). As the bad cop in power, Tymoshenko was more polarizing than Yushchenko’s good cop nature could apparently handle. Her accusation that long-term Yushchenko supporter, oligarch, and cabinet member Poroshenko was guilty of fraud led to Poroshenko’s resignation and Yushchenko’s decision to dismiss the government in what became known by her supporters as the “September massacre.” In the weeks following, Yushchenko shocked everyone by signing an amnesty compact with Yanukovych—absolving those guilty of electoral fraud and other crimes. Subsequent political jockeying split the Orange Revolution coalition— with former campaign manager Zinchenko siding with Tymoshenko on the Poroshenko issue and Kinakh gradually taking his party, the PIE, back into coalition with Yanukovych. In the struggles that followed, Pinchuk and Kuchma often backed Yushchenko (Gillingham 2006: 210). For the next four years, Yanukovych and Tymoshenko alternated in government, yet the tensions between the reduced, but still powerful, presidency and the government left the rules of the political and economic game in constant question.

Conclusion

It is tempting to conclude that the Orange Revolution marked the victory of liberal economic agents over an illiberal government and its rent-seeking,

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big industrial clients. This study finds this picture not so much wrong as incomplete. While we found many entrepreneurs in Kyiv whose sacrifice contributed to the success of the Orange Revolution, it is at least as important to point out that most entrepreneurs from Ukraine’s eastern industrial regions appear to have strongly supported the incumbent regime. It is also interesting that the country’s less developed agricultural regions may have supported the Orange Revolution for its promise to reorient paternalist state policies more toward their needs. Ukraine’s linguisticcultural-regional identity divides clearly played an important role as well (Mykhnenko 2009). One should thus be cautious about claiming the Orange Revolution as evidence for the power of economic reforms like privatization to generate political regime liberalization. Ukraine’s catastrophic first postcommunist decade played out quite as political competition theorists would expect. Where economic reform did come, it was largely because the potentialities of rent-seeking had played themselves out—as they did after the great inflation of 1992–1994 and the financial crisis of 1998–1999. Yushchenko’s reforms as prime minister helped prepare the way for the economic boom of 2000–2004, but the early demise of the Yushchenko government in 2001 demonstrates the limitations of relying on self-serving economic elites to reform themselves. Economic agents played a variety of roles in the 2004 crisis of Ukraine’s competitive authoritarian regime. But it was the regime’s social and political opposition that drove the conflict. Entrepreneurs played a supporting role on both sides. For many of Kyiv’s entrepreneurs, the Orange Revolution promised victory over an economic system rigged against them in the interest of big, politically connected businesses, just as neoliberals would expect. Others, like Kinakh’s followers, jumped to the opposition only when the crisis had weakened the power of the incumbents enough to reduce the penalties of defection to an acceptable level. Still others, like Pinchuk, played both sides—perhaps Pinchuk hoped that he would be able to protect his cheaply acquired steel mill and other perks if the opposition won. Entrepreneurs in the industrialized Donbas, by contrast, saw little potential benefit in an opposition victory and worked against it. Not only did it result in the defeat of one of their own, but it also marked the at least temporary defeat of a model of economic development based on insider control over many aspects of the political economy.

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8 The Political Economy of Regime Change in Serbia, Georgia, and Azerbaijan John Gould with Carl Sickner

Democracy is not an apple you buy at the market and bring back home. —HEYDAR ALIYEV, PRESIDENT OF AZERBAIJAN, JULY 30, 1997

Habits of the past will certainly continue, with many nomenklatura managers forming alliances of convenience with their former political soulmates. But the long-term hope for privatization, for growth, and for democracy must be this: a nomenklatura divided amongst itself cannot stand. —ROMAN FRYDMAN, KENNETH MURPHY, AND ANDRZEJ RAPACZY NSKI ´

re illiberal regimes fated to remain illiberal? As we saw in the previous chapter the mixture of “democratic rules and autocratic methods” characteristic of competitive authoritarian regimes “creates an inherent source of instability.” As instability mounts, incumbents face a “competitive authoritarian dilemma.” Repressing competition is costly, both domestically and internationally. Yet permitting competition may lead to the loss of incumbency or worse (Levitsky and Way 2002: 59).1 To recap, competitive authoritarian dilemmas have an important economic dimension. Under illiberal political conditions, economic agents often find ways to escape the uncertainty of the market. They do so by open political fixes, corruption, or partial reforms. Sometimes, the regime is complicit in the scams; sometimes the regime itself is scammed. Regardless, in economically dysfunctional illiberal states, we should expect to find powerful constituencies seeking to block both economic reforms and political liberalization.

A

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The good news is that this situation is likely to be unstable. Competitive authoritarianism’s democratic rules are embattled. Much of its corruption and self-dealing will be subjected to public discussion. Yet, its autocratic methods will prevent society from doing much about it. The result is underlying tension that explicitly involves the regime’s economic beneficiaries in any regime crisis. Crises are moments of increased uncertainty. Economic agents no longer take their cues from the illiberal structure and their actions become less predictable. As we saw in the Ukraine case, the strategic calculations of economic agents can be quite complex and there are a number of reasons why economic agents who benefit from a client-state relationship might, in a crisis, support an opposition that promises to build the basic institutions of a market democracy. First, patronage obligations are likely to carry both political and economic costs. For firms that do not rely on connections to the state to flourish, a law-governed business environment promises to improve the bottom line. Second, as the regime weakens, the ability of the regime to penalize firms for supporting opponents might also weaken—creating an opportunity for collective action in the business community against the incumbent government. Third, economic agents may also act strategically to improve their position with the successor government. Switching allegiances might help them gain some protection against a program to renationalize cheaply or ill-gotten assets. Agents may also approach the opposition hoping to purchase continued insider access to public policy and legal goods. Allegiance switching thus does not necessarily reflect a conversion to Coasian logic or the principles of a market democracy.

The Rule of Law and the Resource Curse

This chapter investigates two additional complications to this story, the resource curse and clan politics. The literature on the resource curse provides a number of reasons why oil rents and authoritarianism might reinforce each other. Illiberal, resource-rich regimes have both motive and means to repress their opposition. Where political incumbents and their allies monopolize the benefits of oil extraction, liberal democratic institutions can be threatening. They provide opponents with potential access to power and the corresponding ability to deny the incumbents access to oil rents. Incumbents thus have an incentive to keep liberal democratic institutions weak.

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Nor does the rule by executive fiat suppress capital to the same degree as in a manufacturing-service-based economy. Resource wealth cannot flee or hide, because it is literally in the ground. In addition, since the value of resource wealth is fixed by world markets rather than realized through efficient exchange, a respect for property rights and contracts is not as necessary to create wealth. Wealth generation requires little more than a monopoly on the control of the extraction and exportation processes, a healthy accommodation for those with capital and know-how to get the oil from the ground to the market, and willing international buyers. (Easterly 2006: 125; Fish 2005: 127; see also Jensen and Wantchekon 2004; Ross 2001; Sachs and Warner 1995). It is also quite likely that the ability to market a strategic resource, like oil, to the rest of the world will reduce the international price that incumbents pay after an authoritarian crackdown on their opponents (for an example, see Gould and Winters 2007). Nor are oppositions likely to be as effective in resource-rich competitive authoritarian regimes. They easily fragment over strategically offered opportunities to share in the division of resource rents. Since studies show that opposition unity is a crucial factor in successful challenges to authoritarian rule, this too bodes poorly for liberal change (Howard and Roessler 2006). In sum, where oil is present the regime has fewer incentives to restrain itself vis-à-vis society than elsewhere. Resource-rich regimes are not structurally fated to become illiberal. There is no reason established liberal democracies cannot handle the distributive pressures introduced by the exploitation of lucrative resources. Yet where the regime is already illiberal, the introduction of resource rents is unlikely to make it less so. Above all, the rentier nature of wealth creation helps incumbents resolve the tensions underlying Levitsky and Way’s “competitive authoritarian dilemma” (2002). The price of losing power is higher, oppositions are weaker and more easily fragmented, the costs of an authoritarian crackdown are lower, capital is less prone to flee, and the international backlash will be muted. Under such conditions, the competitive authoritarian regime is more likely to choose greater authoritarianism than to attempt its chances with poliltical liberalism. These are powerful incentives for privatization recipients to adhere to the regime in a regime crisis. In some circumstances, economic elites might switch sides should they feel their political chances are better with a rival elite group, but there is likely to be little pretense of seeking to create the fundamental institutions of a market democracy.

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The Role of Patronage Networks

This discussion also bears relevance to the literature on clan and nonclan patronage networks. Kathleen Collins defines a clan as an “informal organization comprising a network of individuals linked by kin-based bonds.” Clans are thus different from shared interest–based patronage networks in that they cohere around intersubjective conceptions of identity, not just patronage. Yet they too perform the important economic and social function of sharing resources according to the principle of reciprocity (2004: 231– 234; although see Junisbai 2010).2 According to Collins, the fusion of oil and clan politics reinforces a state’s illiberal inertia. Incumbent rulers will of course use centrally controlled resource rents to cement loyalty and appease rivals. This raises the value of informal clan identities and business networks as modes of political and economic exchange, and it renders less relevant the rule of law, market competition, an autonomous civil society, the separation of powers, and a system of party representation. Where elites rely on social connections to enrich themselves, liberal democratic institutions lose their value and may even be threatening to clan or business network patrons—the possibilities for democratization thus decline (2004: 259). Where centralized control and resource rents do not play a role, by contrast, we expect that more dispersed wealth and market exchange will leave some room to transform clan politics. Clan identity may not be as crucial to economic survival. At the very least, taking resource rents off the playing field will reduce the intensity of interclan rivalry. Because one can generate wealth in more ways that do not depend exclusively on patronage networks, identity ties may begin to give way to more civic-pluralist forms of political and social organization. Above all, where patronage networks have fewer resources to distribute, the transformation of identity-driven politics is more likely. These observations largely reinforce our hypothesis that oil rents make elite switching less likely. As we shall see in the next section, the dominant form of patronage network informs, but does not fully explain, the divergent Serbian, Georgian, and Azeri outcomes developed below.

The Cases

Does privatization under illiberal conditions fuse the interests of the regime with rent-seeking asset holders? Where this occurs, is the regime sustainable or must the country eventually succumb to either regime liberalization or an

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authoritarian tightening? How do economic elites behave during regime crises? Finally, what is the role of resource wealth in this story and how does the local form of patronage network shape its impact? The following cases provide structured narratives that answer these questions. We examine three competitive authoritarian regimes that underwent the sort of crisis predicted by Levitsky and Way. The independent variable is the broad economic structure of each country: one is a resourcedominant economy, and two are manufacturing-service-based economies. Regime change is the dependent variable in this chapter. Variation on the dependent variable consists of two initially successful instances of regime liberalization and one instance of an authoritarian intensification. We consider patronage networks as an important intervening variable, making a distinction between clan-based and non-clan-based patronage networks. This is summarized in Table 8.1. In the following section, we present structured case studies on Georgia, Serbia, and Azerbaijan. All three waged ethnonational war in the early 1990s and share a number of significant additional similarities: 1. By the mid-1990s, incumbent communist elites in all three countries had “managed” the transition from communism. 2. The process of transforming control of property took place in an illiberal political institutional context. 3. Economic and political interests fused, particularly at the commanding heights of the economy. 4. Fusion contributed to economic mismanagement and distortion. 5. This fusion also created a state-business party of power with an interest in resisting economic and political reform. 6. All three incumbent regimes submitted their interests to a relegitimizing election that each felt it could manage. 7. Each of the regimes used widespread fraud to ensure election victory.

Table 8.1 Case Selection Economy Type Regime Movement During Political Crisis

Manufacturing and Services

Resource Extraction

Serbia, Georgiaa

None Azerbaijana

Liberal direction Authoritarian direction Note: a. Clan-influenced patronage.

None

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8. Finally, the opposition held popularly supported demonstrations demanding reform of the current regime and a transfer of power to the opposition. In Serbia and Georgia, the opposition was able to prevail with at least the partial assistance of elements of the incumbent economic elite. In Azerbaijan, by contrast, the elite remained steadfast, while the opposition crumbled. While the Azeri outcome is by no means structurally preordained, the regime’s firm grip on economic elites may have raised the degree of challenge facing the opposition. We do not argue that the contingent choice of economic elites is a sufficient or even necessary cause of regime change in Serbia and Georgia. We do suspect, however, that elite defection contributed by hampering, splitting, and then isolating incumbent rulers and helping to reinvigorate the opposition.

Azerbaijan The Relation of Economic Elites to the Regime

Heidar Aliyev, the Communist Party leader of Azerbaijan in the 1970s, became president in 1993 after a rebellious army commander displaced the nationalist president, Abulfaz Elchibey. Aliyev survived several assassination plots and attempted coups to build power around the country’s resource wealth. As the state became an extension of his control, he raised its capacity by reforming its structure and enacting limited political and economic reforms. By the late 1990s, Aliyev had cemented a dominant-party coalition with a significant material interest in perpetuating the regime that he founded. Foreign investment played an important role in Aliyev’s rise to power (Cornell 2001: 120; Rasizade 2004: 206). Yet capital inflows did not extend beyond the resource sector and the hotel and service industries that cater to it. By 2003, oil and gas activities accounted for 57 percent of industrial output, and crude oil comprised 70 percent of export earnings. Construction and services related to the oil sector also thrived. The nonoil economy accounted for the bulk of employment, but generated few exports and paid little in taxes (EIU 2004a: 26). Oil remained the only significant economic game in town.3 This game paid enormous dividends, however. The presidential family allegedly drew $1 billion annually from unreported shipments of crude oil (Rasizade 2004: 198–199). Access to this and other sources of oil wealth

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bound Azerbaijan’s economic elite tightly to the regime. As the government used its ability to dispense top positions in the state oil company and ministries as a source of patronage, it had a distinct disincentive to prevent society, parliament, or the courts from wielding greater accountability over its actions (Guliyev 2009). Given the high stakes on the table, the political game was one the ruling coalition was not willing to risk losing. It beefed up its internal security apparatus (EIU 2004a: 13) and increasingly constrained the few liberal democratic freedoms Azeri society retained from the country’s brief experiment with pluralist politics (Bouckeart 2004). It is no accident that Azerbaijan joined Russia as one of the few postcommunist Eurasian countries to undergo a significant decline in its Freedom House scores since 1999 (Freedom House 2007; Guliyev 2009). The Aliyev regime’s economic reform program revealed its priorities. In the mid-1990s Azerbaijan launched a mass voucher privatization program, but refused to include a stake in the national oil company despite indications that it would do so (ICG 2004: 3; Rasizade 2004: 209). Well-armed or well-positioned nomenklatura interests spontaneously privatized most cash-producing ventures in the early 1990s. Today these owners are either directly connected to the regime or have reached some form of accommodation with it (Rasizade 2004: 199–200). This left rather slim pickings for the voucher program. Nevertheless, corruption inevitably undermined even this modest attempt at privatization. Despite the program’s stated goal of turning Azerbaijan into a nation of shareholders, the cash-rich purchased the vouchers from citizens at a fraction of their value. Where enterprises in the program retained value, incumbent managements stripped the value out (Kamrava 2001). Beyond this limited initiative, the regime has been reluctant to challenge its own vested interests with a more aggressive privatization program (ICG 2004: 5). According to the International Crisis Group (ICG), Aliyev maintains a “pyramidal web of patronage and often-institutionalized corruption where regional and clan influences remain strong” (ICG 2004: 9). At the top are the ruling Nakhichevan and Yeraz clans, headed by Aliyev and his family. Influential clan leaders control individual ministries and use the state apparatus to treat the wealth within Azerbaijan as their own (Guliyev 2005: 416– 417). Azerbaijan has the worst rankings for state capture and administrative corruption in the former Soviet Union—indicating that clan and state interests are quite often indistinguishable (Guliyev 2009: 2–3; Johnson 2006: 5–6; Rasizade 2002: 354). As Collins argues, oil rents make the clans more relevant and this undermines the prospects for democratization in Azerbaijan. Farid Guliyev

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adds, “[f]amily, cronies, clans, and patronage are more influential social constructions than formal legal institutions” (2005: 416). Clan connections trump the rule of law, buy exemptions from market competition, and overcome the separation of powers (Guliyev 2009: 4). They also make somewhat of a mockery of the party system. Indeed, Aliyev created the New Azerbaijan Party (YAP) to represent the interests of the ruling clans and reinforce their control over society (Guliyev 2005: 417). Membership in the YAP is a prerequisite for most high-level state employment as well as for many sensitive jobs in the private sector. Not surprisingly, given the distortion in the economy, unemployment and underemployment threatened the majority of the population. Most Azeris are thus susceptible to economic pressure that influences their choice of political activity (ICG 2004: 9–10; Bouckaert 2004: 9). Clans also blur the distinction between the state and civil society. For most members of society civic organizations are unlikely to be as important as identity when representing personal or local interests to the state. Perhaps most importantly, the ruling regime controls the broadcast media. Aliyev’s relatives own several so-called independent television stations. Others are owned by people tied to the regime or vulnerable to regime attacks on their wealth (ICG 2004: 13–14). Clan-based patronage networks reinforce high levels of corruption. Alec Rasizade notes that bribes to senior officials as well as the purchasing of official positions are common practices (2004: 197–198). ICG reports found that while private business can operate, guarantees of protection from the ruling elite ensure that large sums of money flow from business to the ruling elite (2004: 9). This problem is quite extensive. According to the European Bank for Reconstruction and Development (EBRD), 80 percent of companies doing business in Azerbaijan report systematic state extortion, capturing an unofficial tax of 10 percent of annual revenue (cited in Rasizade 2004: 199). Ministers then launder this money through private banks controlled by their respective clans. Ministerial patrons also ensure that these banks are protected from occasional government crackdowns on corruption (Johnson 2006: 5–6). Elite Solidarity and the 2003 Elections

The combination of clan politics and oil rent reduces the options for economic elites to exercise free agency. We would thus expect little movement among economic elites during regime crises. Oil raises the stakes of political competition. Incumbent stakeholders realize that if a change of power occurred, entire clans, including members of the ruling YAP, would lose

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their access to the resources of the state and might face various forms of retribution. As Human Rights Watch noted: [P]olitics [is] an all or nothing game: a party either controls the presidency and with it all of the institutions of power, as well as most of the employment opportunities in the country; or it controls nothing, and its supporters face impoverishment. In this scenario, it is not surprising that government officials from the national to the local level participated so vigorously in the election abuses and fraud; their jobs and economic survival were on the line. (cited in Bouckaert 2004: 10; italics added)

With an ailing President Aliyev in Cleveland, Ohio, undergoing medical treatment and his untested son attempting to consolidate the power he obtained through extraconstitutional means, the fall 2003 elections were perhaps the perfect time for the opposition to score a democratic breakthrough. Instead, they showed remarkable weakness. Similar to YAP, opposition parties in Azerbaijan represented “regional-based kinship links and loyalties” rather than political ideologies (Guliyev 2005: 417). This made it difficult for opposition parties to unite or stay united for ideologically driven goals. They easily broke ranks for financial reasons. They were unable to maintain nonviolent discipline in their ranks, and violent encounters were often incited by agents provocateurs. They soon became associated with violence and nationalistic pledges to reignite a conflict with neighboring Armenia over the contested region. This may have cost them some international support. Nor did they receive much support from the leading clans’ business elites and the various media they controlled. Far from going into the elections with a sinking ship, oil kept the Aliyevs’ grossly deformed vessel tight and dry. No key incumbent elites crossed lines. On the contrary, hoping to retain their lucrative rents, elites closed ranks with the incumbents (Valiyev 2006: 29). They have continued to do so in the years since (Guliyev 2009). This does not mean that elites will never defect from the regime. It does mean, however, that the challenge involved in reversing Azerbaijan’s illiberal trajectory has continued to remain formidable.

Georgia Georgia and the Relation of Economic Elites to the State

Eduard Shevardnadze faced marked challenges as he replaced Georgia’s elected leader, Zviad Gamsakhurdia, to become interim leader of Georgia

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in January 1992.4 First, a diverse coalition of pro-Western democratic intellectuals, clan elites, and paramilitary formations selected Shevardnadze as a trusted broker of collective interests. Many saw him as the embodiment of their Western aspirations and one who promised a more inclusive normalcy that would be less threatening to minorities than Gamsakhurdia’s Georgian nationalism. Yet regional leaders, the clans, and paramilitaries also had an interest in keeping the center weak. Second, Shevardnadze’s state apparatus contended with an array of well-equipped armies vying for control over Georgian territory. Some of these, in turn, either secured the backing or the enmity of Russia, creating severe diplomatic headaches (Nodia 1995: 111–114). Finally, Georgia did not have Azerbaijan’s oil to dispense patronage through clan and other patronage networks. At the same time, Georgian enterprises reeled from disorder and severed access to Soviet-era suppliers, finances, and markets (Muskhelishvili and Akhvlediani 2003: 9). Nevertheless, by the mid-1990s, Shevardnadze secured a new constitution and won a dominant position for his party, the Citizens Union of Georgia (CUG), in parliamentary elections. In the same free and fair elections, he secured the presidency (EIU 2004b: 6; Tsereteli 1996: 42–43). The new constitution formally favored the president and his advisors over parliament. But Shevardnadze’s informal need to compromise with rival clan leaders left the center relatively weak vis-à-vis the regions (EIU 1997: 12). Unable to buy loyalty by dispensing rents, he allowed important players to strip and extort assets “to feed their network” (see Collins 2004: 244). This included turning an official blind eye to smuggling, trafficking, and organized crime’s monopoly in gasoline distribution (Fuller 1995: 64). Most officials felt little compunction about turning to corruption to supplement their low official income. Shevardnadze even allowed corruption in the power ministries to help compensate their poorly paid workers (Darchiashvili 2003: 13). Apartments, houses, and individually held plots of land had been privatized in 1992, but legislators put off privatizing larger Soviet-era enterprises. In the interim, managers simply took de facto control over assets. Parliament attempted voucher privatization in 1995–1996. Yet, similar to Azerbaijan, politically connected insiders expropriated most resources of value. Vouchers finally traded for less than 20 percent of their nominal worth (Muskhelishvili and Akhvlediani 2003: 10). Subsequent attempts to auction larger Soviet-era enterprises similarly proved to be problematic. Stripped assets, Soviet-era management, redundant workers, obsolete equipment, and a lack of markets deterred most potential investors. Those who showed interest usually backed off in the face

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of onerous tender conditions, often imposed on the insistence of enterprise insiders. Meanwhile, clan and criminal groups—the main players in the economy with cash—played an influential role in early small and mediumsized privatization programs. By the mid-1990s, both were well established in Georgia’s private sector. Central control over macroeconomic policy levers allowed Shevardnadze to embark upon economic stabilization in 1994–1996. Working with international organizations, the government introduced a stable, wellanchored national currency, liberalized most trade, freed prices, and exercised fiscal and monetary restraint. Bouncing back from hyperinflation that had topped 57,000 percent, Georgia achieved 11 percent real growth in 1996–1997 (EIU 1997: 10; Muskhelishvili and Akhvlediani 2003: 10–11). In addition to the improved economic environment, the government curbed the power of paramilitary groups, ended a three-way civil conflict, secured international investment into the Baku-Tbilisi-Ceyhan pipeline project, and completed small business privatization, which led to a limited boom in small shops and restaurants. Civil society also developed along with the growth of the independent media (Nizharadze 2004: 82). The economy continued to grow after the Russian financial crisis of 1998, but at a slower pace. Meanwhile, the balance of Georgian economic activity had switched decisively away from medium and heavy manufacturing. These large industries, however, continued to exert a drag on the economy (EIU 1997: 22). By the end of the decade, Shevardnadze presided over a weak state, ultimately tied together by numerous, but tenuous, forms of patronage binding a shifting pact that kept his party in power. Unlike Azerbaijan, where oil fueled and reinforced clan hierarchies, in Georgia the center could often do little more than coordinate and broker between rival interests. Still, the center was the first among equals. Connection with Shevardnadze’s family or associates became crucial to controlling the large property assets still in state hands or securing scarce credit. Typically, the government allowed personal monopolies and rewarded friends with administrative positions from which they could extract bribes. Shevardnadze bought little from these concessions other than minimal cooperation. Provincial authorities maintained a high degree of independence from Tbilisi, the capital, and often ignored directives from the center. Meanwhile, national security deteriorated with new challenges from Abkhazia and Anjara, two breakaway regions (Antelava 2003a; Nizharadze 2004: 82–83). Economic society thus had difficulty generating a supply-side response to the macroeconomic improvements won during stabilization in 1995–

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1996. Inflation might have been low, but entrepreneurs still had to contend with politically allocated credits, personalized and informal contract enforcement, informal barriers to entry in monopolized markets, an excessive number of regulatory agencies, and all sorts of bureaucratic roadblocks. Growth might have been positive, but entrepreneurs resented the official cut and must have realized that the internal market, and hence their profits, could have been larger and freer. They were also concerned about high tax rates and the difficulty of attracting much-needed foreign investment (Muskhelishvili and Akhvlediani 2003: 12; Papava and Tokmazishvili 2006: 27–28). Fiscal austerity and state enterprise mismanagement also hurt Georgian citizens. Unemployment remained high throughout the 1990s and early 2000s, and unpaid salaries, small pensions, and severe electrical shortages plagued the population. According to World Bank findings, from 1997 to 2000, 20 percent of the population lived in absolute poverty at any one time; 60 percent experienced it at least once during the same period (Muskhelishvili and Akhvlediani 2003: 12; World Bank 2002a: 8, 11–13). At the time of the 2003 parliamentary elections, Marina Muskhelisvili and Anna Akhvlediani found that “private property and private economic activities [were] still broadly based on political-clientelist protection rather than on the rule of law and legal machinery” (2003: 10). Holding on to what you had often required some form of privately arranged protection. The Lack of Elite Solidarity with the Regime

Shevardnadze’s ruling CUG contained a group of young reformers who wanted to push for economic and judicial reforms. Yet their measures threatened regional interests and many state clients. Parliament repeatedly blocked them (Jones 2000: 52). After extensive street protests met a hamhanded government attempt in 2001 to shut down Rustavi-2, Georgia’s most critical independent television at that time, the young reformers left to form opposition parties. Minister of Justice Mikhail Saakashvili left the Shevardnadze government and the ruling CUG to form the United National Movement (UNM). Parliamentary chairman Zurab Zhvania soon followed. He was joined in 2003 by his successor, Nino Burjanadze. Together, Zhvania and Burjanadze formed the Burjanadze-Democrats. The UNM and the Burjanadze-Democrats quickly became the strongest opposition groups— voicing many of the typical concerns of market democrats (Chikhladze and Chikhladze 2004: 4; Nodia 2004: 73; Welt 2006: 8–9). While Shevardnadze’s little oligarchs remained staunch supporters, business did not provide a united front. Some business interests pushed for

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reform. This did not always extend to open political opposition, but some did join the various opposition parties, while others formed their own. Entrepreneurs organized associations to express concern about corruption, high tax rates, and other elements of the unfavorable business environment. Industry Will Save Georgia (IWSG) was created in April 1999 by prominent businessmen and members of the Industrialists Union, and represented the interests of medium-sized private firms. A second business-interest party, New Rights Party (NRP), was formed in 2000 when a group of politicians representing the business community defected from the CUG. These two parties performed quite well in regional elections in 2002 (Muskhelishvili and Akhvlediani 2003: 13). Georgia’s 2003 parliamentary elections took place against a backdrop of economic and institutional crises. As opponents challenged the official results, Shevardnadze’s support evaporated. Without oil revenues to bind elites to his side, his fragile pacts with industrial, regional, and clan-based brokers gave way to a scramble to find new arrangements. Organized criminal entrepreneurs, of course, preferred to keep their violently enforced monopolies, but elsewhere Shevardnadze’s opponents tapped into significant discontent with the Georgian political economy. While the IWSG and NRP chose not to protest the fraudulent elections through participation in the postelection street demonstrations (though NRP protested through more quiet channels; see Welt 2006: 24), the fact that such political parties existed at all shows that at least some of the business elite were unsatisfied with the Shevardnadze regime’s response to the poor business environment (Chikhladze and Chikhladze 2004: 4–5; Jones 2000: 55– 57; Muskhelishvili and Akhvlediani 2003: 12–13; Nodia 2003: 12; Welt 2006: 8). Some members of the economic elite also used their economic power to support the opposition during the fall 2003 election. In the realm of broadcast media, the owners of Rustavi-2 provided critical support. Most people in Georgia received their news from television. By far the most professional, popular, and critical opposition station at that time was Rustavi-2. Prior to the 2003 parliamentary elections, the station played an important role in creating public space for the opposition candidates to voice their opinions and political platforms. By all accounts, Rustavi-2’s support for the opposition helped drive protests as the government attempted to reengineer its majority in fall 2003. Rustavi-2 aired footage of electoral violations, quickly released exit poll and parallel vote tabulation (PVT) results, and provided continual and favorable coverage of the resulting protests. The Imedi and Mze television stations, both linked to the business elite, also provided regular coverage of the demonstrations. Though neither Imedi,

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linked to the powerful oligarch Badri Patakartsishvili, nor Mze, linked to both regime backers and the NRP, initially supported the opposition, Cory Welt argues that they may have switched sides to retain a share of the market. With Georgians glued to their televisions, coverage simply made good business sense (2006: 33). Yet, the owners must have known that the broad coverage would raise participation in the protests and acts of civil disobedience (Antelava 2003b; Chikhladze and Chikhladze 2004: 13; Fairbanks 2004: 119–120; Mitchell 2004: 345; Welt 2006: 31–35, 62, 64–65). For the most part, Saakashvili’s subsequent behavior in office was a partial disappointment. The government investigated many members of Shevardnadze’s family and associates (Papava and Tokmazishvili 2006: 30) and recovered hundreds of millions of dollars for the state budget (Kukianidze 2009: 231). Reduced corruption, better tax collections, and a general stabilization of the macroeconomy produced a period of rapid growth and a tripling of state revenue (George and Stefes 2008: 346; Mitchell 2009: 173–176). Yet, as in Ukraine, the postrevolutionary experience did not lead to an unambiguous liberalization of the political economy. Buoyed, initially, by strong popular support, Saakashvili concentrated power in the executive branch, sought UNM hegemony in parliament, marginalized his opponents, and harassed the media and civil society. Given this agenda, he has deliberately kept the courts weak and subservient. By the end of 2007, Saakashvili’s creeping authoritarianism had produced opposition protests and a partial boycott of the parliamentary election. His isolation also contributed to the decisions leading to the disastrous war with Russia in 2008 (Cooley 2008; George and Stefes 2008; Mitchell 2009; Welt 2009). While Saakashvili’s brand of competitive authoritarianism has been associated with some market liberalization, several associates who were closest to former president Shevardnadze went untouched long after the elections, while others were merely arrested, fined, and released rather than convicted and expropriated. If there is an inference to be made, it is that while there may have been a strong market democratic current of support behind Shevardnadze’s removal from power, many elites successfully switched allegiances in an effort to preserve their property (EIU 2006; but see also Papava and Tokmazishvili 2006).

Serbia The Relationship of Business Elites to the Regime

Serbia’s business class emerged through a tight interest-based patronage relationship with Serbian leader Slobodan Miloševi´c. While a relatively vo-

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ciferous but fractious opposition existed throughout the 1990s, Miloševi´c’s governing party retained a monopoly on most of the important channels of political influence. He used this to control economic transformation programs in ways that reinforced his own power. Miloševi´c inherited a relatively robust privatization framework from the government of Ante Markovi´c, former federal prime minister. This program converted firms into joint stock companies and provided employees with incentives to buy shares. Wartime hyperinflation, however, deflated share prices to such low levels that parliament felt justified in renationalizing many companies and turning their administration over to the dominant creditor—generally a state-owned private bank directly or indirectly controlled by Miloševi´c’s governing Socialist Party of Serbia (SPS). Parliament and SPS-controlled municipalities also became adept at using local emergency powers to replace the management of local socially owned enterprises. Miloševi´c used both of these channels of enterprise governance to buy off enemies and reward friends with enterprise directorships. As state salaries were generally quite low, many directors became rich through stripping assets of privately controlled firms and revenue diversion (Freedom House 2000). More broadly, politically connected directors had privileged access to government goods that would be publicly available under a well-run market democracy. This included scarce credit, hard currency, import licenses, and favorable treatment from the full range of bureaucracies typical of a predatory state apparatus. Many directors got rich reselling scarce stateallocated resources on the black market (Brankovi´c 2002: 218–219; Gagnon 2004: 118–119). While Miloševi´c busily nurtured a loyal tycoon class, the population had to get by on a fraction of their 1989 incomes. This increasingly rankled. Worse, Miloševi´c’s associates and friends included criminal elements. A number of these were nurtured to break sanctions for the government or its clients. These groups often operated from within the state or with state protection. They got rich by smuggling oil, arms, drugs, cigarettes, and human traffic. Miloševi´c or his associates allegedly also tapped into organized crime to eliminate key opponents by means that may have extended to murder (Brankovi´c 2002: 218; Gordy 2004: 11). The Lack of Elite Solidarity with the Regime

By the late 1990s, Miloševi´c had lost his original broad worker and nationalist backing and relied on a narrow cadre of rent-seeking bureaucrats and businessmen whose only feasible business plan was to exploit ties to Miloševi´c, his family, or his close associates (Brankovi 2002: 210; Gagnon

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2004: 187). Beyond his immediate circle, these patronage ties were cemented by mutual economic and political need rather than identity ties. After the 1999 NATO bombing, Miloševi´c began to crack down on the more extreme, embarrassing, or independent organized crime elements associated with his regime (Gagnon 2004: 185).5 This betrayal led some clients to throw support to various political opposition parties. The opposition then used the new ties to finance their activities (Andreas 2004: 4). V. P. Gagnon speculates that having already secured immense wealth through criminal and quasi-legal means, business elites outside of Miloševi´c’s close family circle no longer cared who controlled the state. Miloševi´c’s political opposition now allegedly assured leading organized crime figures and state security figures that they would be able to keep their wealth and positions following the election. As importantly, leading opposition politicians purportedly pledged to allow the business elite to retain “control over resources of the [postelection] system” (2004: 185). This latter point is crucial because it demonstrated that the beneficiaries of illiberal political mismanagement (and what Gagnon terms “insider privatization”) did not switch allegiances because they wanted the new government to build a market democracy. Rather, they switched because opposition elites assured them that they would not. Indeed, it is probably no coincidence that when Zoran Djindji´c, the prime minister, attempted to crack down on criminal elements in 2003, he was assassinated by Miloševi´c’s informal security and organized crime interests. This reopened a divisive debate over efforts to decriminalize Serbian politics and business (Gordy 2004: 14). Prior to the 2000 election, however, most defections occurred behind the scenes. Defecting businessmen occasionally financed both sides of the campaign. The most visible of these defections was from media baron Bogoljub Kari´c. It was visible largely because his defection involved directing his independent television station, BK TV, to provide leading opposition candidate Vojislav Koštunica favorable media coverage. The gamble paid off badly, however. Kari´c later fled into exile to avoid various corruption convictions.

Conclusion

This chapter has explored the neoliberal proposition that the corrupt, rentbased, political economy of a competitive authoritarian postcommunist regime might eventually become frustrating to property transformation winners. If a government fails to respect the rule of law and enforce contracts,

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capital flees or hides, local investment declines, and growth within the affected sectors slows. Even politically connected entrepreneurs might eventually realize that there is only so much revenue to be squeezed from state capture. As the benefit from rents brings marginally diminishing returns, and as political crisis looms, they may choose to switch allegiances to an opposition promising to build the basic institutions of a market democracy. We expected that the exception to this pattern would be found in resource-dominant economies. For those with access to rents drawn from the state-controlled resource sector, there are few diminishing returns to corruption—as long as crucial resource sector investors are kept happy. Far from switching allegiances to oppositions promising to build a rule-based market democracy, times of political crisis involve a scramble to shore up incumbent political institutions, as well as to secure a political leadership that will ensure future access to rents. These dynamics are even more robust where the politicized distribution of rents occurs through identity-based networks, such as a clan. The theoretical implication is that privatization under illiberal political conditions is not necessarily an effective instrument in building demand for the institutions of market democracy and may even complicate the path to get there. Nevertheless, we find confirmation here of an approach that, like neoliberalism, takes the long-term agency of postproperty transformation actors seriously. As expected, there was a lack of evidence for allegiance switching in Azerbaijan and some evidence for it in Serbia and Georgia. Our examination, however, did not always reveal contingent market democrats where we expected to find them. Switching did occur in Georgia and Serbia, but evidence indicates that, as in Ukraine, at least some economic agents were motivated less by a desire to reconfigure the institutional base of economic activity around the rule of law than by a scramble to preserve their assets and, if possible, preserve their sources of rent under new political conditions. In other words, we found agents acting wholly consistently with their structural roots in an illiberal postcommunist trajectory. Basing one’s economic future on one party of power is politically risky. Given popular mobilization, opposition unity, international condemnation, and a few elite defections, politically connected entrepreneurs may abandon the incumbent party and seek an accommodation with the opposition. Accommodation does not necessarily mean that stakeholders in the old regime are willing to abandon the quest for easy rents. Many private entrepreneurs may be willing to compete under the uncertainty of markets and democracy. But evidence suggests that a number of Serbian and some Georgian actors simply sought to retain their political guarantees of economic success.

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In Azerbaijan, by contrast, the economic elite remains beholden to the party of power—an allegiance reinforced by the distribution of rents through business- and clan-based patronage networks. Those who resisted state power were simply expropriated, driven into exile, or both. The Aliyevs have gotten away with this because they realize that one does not need the rule of law for economic survival if one controls the oil sector. The regime simply needs top-down local control and the promise of enough revenue to keep a crucial subset of foreign energy investors happy. If this drives away investment in other sectors, that is no problem—one can draw ample revenue from the single state-controlled sector. In 2003, it was thus of little surprise that Azerbaijani elites closed ranks around the Aliyev family, while its security forces physically broke the backs of its opponents. Liberal political and economic institutions are hard to come by. Yet, for those countries that failed to liberalize upon the collapse of communism, the news is not all bad. Competitive authoritarian regimes possess internal economic dynamics that may produce crises, energize oppositions, and split the regime from its own economic allies. Where oil rents dominate the economy, however, the task of bringing economic elites into the liberal fold is far more challenging.

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9 Beyond Creating Owners

When a country is well governed, poverty and a mean condition are something to be ashamed of. When a country is ill governed, riches and honors are something to be ashamed of. —CONFUCIUS

number of assumptions justified privatization programs after the fall of communism. Advocates expected that private owners could outperform the state in providing better oversight and direction to firms. They also hoped that new owners would advocate additional economic and political liberalization in the hope that fewer bureaucrats and more accountable politicians would help reduce the cost of doing business in an illiberal postcommunist environment. Given these positive expected outcomes, neoliberal postcommunist privatization advocates were often agnostic about the means by which property was transferred to private hands. Indeed, private property was a priority end that permitted a range of politically expedient methods. Programs were best designed strategically—with the goal of overcoming resistance to property transfers. This often meant accommodating the needs of crucial political stakeholders. This book has found these assumptions and prescriptions not so much wrong as incomplete. Its broader contention is that the conduct and impact of postcommunist privatization are best understood when examined in its political context. A focus on the politics of privatization adds three additional perspectives to the typical economic discussion about privatization.

A

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It also provides a window into the role privatization has played in constructing Europe’s postcommunist societies. The following discussion summarizes these perspectives.

Endogeneity

The first perspective is that political context matters for the selection and performance of privatization programs. As academics realized early in the postcommunist period, reformers did not design privatization programs in a political vacuum. Rather they designed their frameworks from a menu of possible choices constrained by broader political inheritances (Stark 1992). More democratic societies chose programs that reflected the political standing of the left at the time of transition. Where there was no history of reform communism as in Czechoslovakia and where management and labor organizations were associated with the previous discredited regime, bureaucratic and enterprise insiders were less able to use democratic means to secure a meaningful role in the property distribution process (Gould 2003). This did not mean that the subsequent privatization programs would be free from corruption or particularly well run. The Slovak and Czech experiences show, however, that liberal political competition and government turnovers could help serve to limit the economic damage that poor economic decisions would inflict (Orenstein 2001). Illiberal political systems, as demonstrated in the case of Ukraine, permitted the beneficiaries of the old regime to shape or even control the transformation of the political system. Not surprisingly, they designed privatization programs to convert their communist-era positional power into postcommunist economic wealth. Their privileged and often illiberal access to a country’s important assets might have been excusable had the new owners then fought to build a market democracy as neoliberals predicted. But all too often the new owners supported the consolidation of an illiberal political economy brokered by a comparative authoritarian regime. In Ukraine, Serbia, Azerbaijan, and Georgia, new owners did not—at first—advocate a broader liberal economic transition. Rather they often took advantage of the illiberal political climate to abuse their privileged political access to economic policymaking. Unable to use the political process to dislodge the rent-seekers, societies suffered a period of prolonged economic dysfunction with the emergent economic elite, who were, at best, agnostic about the political and civil liberties of their fellow citizens.

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Power Politics

A second perspective that the economists have often missed is privatization’s role in building and maintaining political power. Arguably, power— not economic efficiency—was the primary goal of privatization for many, if not most, postcommunist governments. This is at least partly due to the unique nature of postcommunist privatization programs: in contrast to privatization in Western market economies, there was a larger share of the national wealth to transfer and an evident need to do it quickly. The number and amount of the assets, and their importance to the national economies of each country, greatly raised the stakes of the privatization game. Indeed, the choice of privatization framework would determine the economic elite of the country for years to come. Privatizers often preferred to win by breaking the rule of law than to lose by adhering to it. Privatization conflicts could thus catalyze attacks on liberal political institutions. As the Czech case demonstrates, the power perspective can even apply to liberal postcommunist cases where liberal political institutions were relatively robust from the start. Václav Klaus used voucher privatization to build support for his political party, the Civic Democratic Party (ODS), prior to the 1992 Czech Republic parliamentary elections. Subsequently, Klaus also appeared quite pragmatic in his choice of friends, welcoming into his orbit privatization winners from the banks and financial intermediaries and from nomenklatura elites with murky ties to the communist past. Yet, democratic constraints helped restrain Klaus and Czech actors in their scramble for wealth and power. Elsewhere, however, where these restraints were weak or absent, the relationship between privatization and power reinforced illiberal practices. From the start, illiberal governments saw privatization as too important to allow genuine access to outsiders. Populist voucher programs in Ukraine and Azerbaijan, for example, masked the reality of insider-dominated frameworks that would ensure wealth transfers to political allies. In Serbia, Slobodan Miloševi´c used control over state-managed firms and privatization as a means of rewarding friends and buying off enemies. In Ukraine, Georgia, and Azerbaijan, large-scale privatizations rewarded friends and helped buy the cooperation of regional power brokers. Virtually everywhere, insiders helped keep minority shareholder rights weak, and efforts were made to direct scarce credits and provide other state-directed policy perks to political friends. All four governments defended these actions against political competition through attacks on the independent media, civil society, and the political opposition.

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No one took the power politics of privatization lightly, but Vladimír Me¸ciar perhaps played it hardest of all. He inherited liberal democratic institutions and a highly popular voucher privatization framework that primarily benefit his opponents. Strengthening his power base thus entailed going to extraordinary and often undemocratic lengths to sideline and then eliminate the voucher program. His government’s attacks on the president, the courts, parliament, the opposition, and civil society were thus at least partially motivated by a desire to personalize control over privatization decisions and secure more loyal economic elites.

Rent-Seeking

A third political perspective on postcommunist privatization is the incentive of postprivatization economic actors to conspire to secure a guaranteed profit rather than compete for one. This is not a heretical statement—the classical political economy of Adam Smith was founded on a healthy distrust of economic actors. Having observed the efforts of eighteenth-century merchants and manufacturers to restrict competition and raise prices, Smith would likely agree that it was a mistake to assume that postprivatization actors would restructure for profits when rent-winning opportunities abounded. Given the failure of poorly regulated postcommunist markets to generate genuine enterprise restructuring, market advocates belatedly rediscovered the need for more robust institutional frameworks—particularly minority shareholder protections, a disciplined financial sector, and an effective commercial judiciary. It took a painfully long time for analysts to understand the difficulty competitive authoritarian leaders had in creating these and other market-enhancing institutions. Because such reforms threatened the interests of rulers’ allies and political supporters, they were likely to be launched only where the level of economic dysfunction became so costly as to threaten their interests. If we can draw only one lesson from the postcommunist privatization experience it should be that economic dysfunction is rarely the result of a lack of political will or skill. Returning to Smith and more recent work by Joel Hellman (1998) and others, we need to remember that economic dysfunction—from client-driven trade barriers to hyperinflationary policies— usually has its beneficiaries. These are usually both willful and, unfortunately, skillful actors who will profit when possible at extreme public expense.

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The defense of rent-seeking and corruption is thus a major part of the postprivatization story. Economic actors privatized to get rich and influential, not necessarily to make the economy more efficient. Privatization was more likely to produce market-competitive entrepreneurs when their enterprises faced hard budget constraints, vigilant market watchdogs, and a lawabiding government. Under such conditions, companies usually had to produce something marketable to survive. But the bottom line of this lesson is that such market-enforcing institutions were more likely to emerge where politicians felt more accountable to the general public than to influential clients. This discussion implies a reciprocal relationship between competitive markets and liberal democracy. Competition is the common currency of both—and the survival of competition in one sphere can often depend on its survival in the other. Put differently, a government that has monopolized political space can often monopolize economic space as it sees fit. Conversely, economic monopolies may transfer into overwhelming advantages in the political sphere. To the extent that future policymakers have freedom to make free choices in choosing a privatization program, they should keep in mind that they are not just creating entrepreneurs; they are empowering potential political agents. Nor can it be assumed that these agents will automatically demand the institutions of market democracy. Indeed, as we’ve seen in the last two chapters, postprivatization agents put their political energy into a broad range of efforts. They are more likely to defend illiberalism where their riches depend on politically procured rents rather than market success, or where a liberal opposition threatens them with penalties for participating in a corrupt privatization program. They are more likely to resent illiberalism where they need to produce a marketable product to survive or where predatory government behavior leaves them no choice but to join the opposition. Yet even market democrats have provided support to authoritarian regimes. As we saw in Ukraine, they may have faced intense pressure or adhered to the regime for identity or other reasons. The main point is that entrepreneurs’ support for liberalization is contingent on a range of factors. Sadly, we cannot rely on marketization strategies alone to bring about liberal political change. Insider privatization programs may be necessary to secure support for property transformation. Yet given a choice, reformers should simultaneously or even a priori establish disciplinary market institutions and work to build, rather than to circumvent, institutions enhancing political accountability. Without hard market and political contraints, privatization

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risks reinforcing illiberalism by creating insider economic elites who are able to monopolize economic policy to their advantage. To the extent that policymakers have the freedom to do so, privatization programs should be designed with an eye to preventing the reproduction of fused economic and political power. If they cannot, privatization should be delayed until they can.

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Acronyms

AZZZ CDU CIS CMEA ˇ CSSD CUG DS DU EBRD FDI FIGs FNM HZDS ICG IDS IMF IOC IPF IRB IWSG KDH NATO NBS NBU

Federation of Employers Unions and Associations Christian Democratic Union Commonwealth of Independent States Council for Mutual Economic Assistance Czech Party of Social Democrats Citizens Union of Georgia Democratic Party Democratic Union European Bank for Reconstruction and Development foreign direct investment financial industrial groups National Property Fund Movement for a Democratic Slovakia International Crisis Group Industrial Union of Donbas International Monetary Fund international oil companies investment privatization fund Investment and Development Bank Industry Will Save Georgia Christian Democratic Movement North Atlantic Treaty Organization National Bank of Slovakia National Bank of Ukraine

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ACRONYMS

NEZES NRP ODA ODS ODU OECD OF OS PIE PSIS PVT SCM SDK SDL’ SDPU SIS SKDH SKDU SMK SNC SNS SOP SPB SPF SPP SPS UNM VPN VSŽ VÚB YAP ZRS

Association of Independent Slovak Economists New Rights Party Civic Democratic Alliance Civic Democratic Party Civic Democratic Union Organization for Economic Cooperation and Development Civic Forum Civic Movement Party of Industrialists and Entrepreneurs First Slovak Investment Company parallel vote tabulation Systems Capital Management Slovak Democratic Coalition Party of the Democratic Left Social Democratic Party of Ukraine Slovak Information Service Slovak Christian Democratic Movement Sloval Christian and Democratic Union Slovak-Hungarian Coalition Slovak National Council Slovak National Party Party of Civic Understanding Slovak Savings Bank State Property Fund Slovak Gas Company (“Industry”) Socialist Party of Serbia United National Movement Public Against Violence Východoslovenské železiarne (Eastern Slovak Steelworkers) General Credit Bank New Azerbaijan Party Association of Slovak Workers

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Endnotes

Chapter 2 1. For more on the basic problems of diminishing marginal returns in development planning, see Easterly 2001. 2. This story is adopted from an anecdote frequently related by David Stark. I retell it here as a generalized, exemplary story using stylized data. It is not a specific case study. For a more thorough discussion of the informal logics that emerged under central planning, see Stark 1989. 3. Indeed, given that most planners were men, and that less concern was given to consumer items in any case, there was a notorious shortage of feminine hygiene and birth control. In some countries, like Romania, the lack of birth control and abortions was deliberate—an effort to induce women to produce more children, who would then provide additional labor inputs for the economy (Stokes 1993: 67). 4. I use the term neoliberal here interchangeably with radical and market reformer. 5. The following categorization is taken from Mandelbaum (1993: 1–15). The grouping into three categories is somewhat subjective. Other economists, including Islam (1993), have added categories or chosen other categories instead of those chosen here. Most, however, undertake the same practical policy measures discussed here with slightly different emphases on speed and sequence. For more on this debate, see Crawford 1995; Fischer and Gelb 1991; Islam and Mandelbaum 1993; Jowitt 1992; Kornai 1990; Lipton and Sachs 1990; Marer 1993; Nove 1995; Przeworski 1991; Sachs 1994.

Chapter 3 1. The effects of structural adjustment are not gender neutral. Hardships fall disproportionately hard on women (Moghadam 2005).

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2. The conclusion was that the introduction of democratic institutions at the outset of the transition would provide the losers of reform with an institutional resource by which they could prevent or compromise the soundness of economic reforms. This, in turn, would have a feedback effect on the quality of democracy. John Hall wrote, “The immediate consequence of democracy is likely to be the rejection of economic reform. If this becomes full blooded, disaster will surely follow. For the legitimacy of the new regime can only be secured by some measure of economic success, and this will never occur unless the principle of the market is embraced” (1995: 89). 3. While advocating radical reform, Przeworski also advocated government spending to maintain investment during the downturn (1993: 132–198). 4. The Czechoslovak planning process and early privatization design also reflected Balcerowicz’s thinking. Dušan T¸ríska argued that reformers had to privatize quickly before those hurt by reform could identify their interests and consolidate into distributive coalitions capable of effective collective action (1991a; see also Blanchard and Layard 1991). 5. See also Jeffery Sachs’s more recent chapter on clinical economics. The diagnostic process is much improved and no longer technocratic, but the essential metaphor of doctor/patient still holds (2005: 74–89). 6. Much of this literature—particularly that based in a public-choice methodology—is pessimistic about the self-transformative capacities of liberal democracies and hints that economic liberalization is much more likely to be successful if staged before political liberalization. Various authors point to the tendency of democratic political systems to over-reward well-organized, rent-seeking pressure groups. “Under democratic regimes, these groups have access to government, and they lobby, bribe, strike and vote to persuade governments to allocate resources to them” (Crawford 1995: 4; Olson 1984; Przeworski 1993: 45–52; Williamson 1994). 7. Grzymala-Busse provides a more nuanced discussion of forms of state capture (2008). For supporting evidence from international financial institutions, see IMF 2003: 105–111; IMF 2000: 93; World Bank 2002b. 8. Albeit faced with political realities, neoliberals in positions of influence often strategically adopted their tactics to get basic reforms accomplished (Shleifer and Treisman 2000: 8–11) or they accepted, but lamented, their inability to impose the full blueprint (Schwartz 2006: 25–26). Yet in other cases, neoliberals have distinguished themselves by their willingness to value utopian ends even when the short-term means have been catastrophic. James Scott warns of the potential for deadly social mayhem whenever a prostrate civil society is unable to resist administrative visions imposed on society using the unrestrained power of the state (1998: 88–89). Arguably, these conditions were fulfilled in relation to a neoliberal project in Chile under Pinochet, and at least partially fulfilled in Russia under Yeltsin. (For a critique of the neoliberal ends-means mindset in the Russian case, see Klebnikov 2000: 101–109.) 9. Orenstein adds the caveat that societies must be committed to the project of building markets and democracies. His hypothesis is thus perhaps less helpful for countries in which the alternative to liberal reformers is unreformed communists, ultranationalists, or theocratic zealots (2001: 130–134). 10. For a superb attempt to address this issue, see Ekiert, Kubik, and Vachudova 2007: 20. 11. However, Russian and Czech privatizing teams both sought to avoid direct

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control by the workers. Rather than restructuring the enterprise, they feared, among other things, that workers would use their control to avoid layoffs and maintain wage levels (Boycko, Shleifer, and Vishny 1995; T¸riska 1991a). 12. For a detailed discussion of the diverse range of actors competing for state property, see Barnes 2006: 9–12. 13. For additional detailed case studies, see Gould 2003. 14. According to Boycko, Shleifer, and Vishny, the exception is an employeedominated ownership structure that creates a conflict of interest between the agent as employee (maximizing salary and benefits) and the agent as owner (maximizing profits). They feared the agent as employee would dominate, leading to an inefficient and even disastrous ownership structure (1995). 15. Note that this does not rule out the possibility of strong private-public collaborations that work. The main critique here is not of a coordinated market economy, but of illiberal political conditions that allow the coordinators to conduct their work on their own behalf with impunity. In the postcommunist case, liberal politics produces better coordination, because it holds administrators and agents more accountable to public ends. To the extent that authoritarians can impose accountability on their bureaucrats, they may be able to avoid some of the pitfalls of postcommunist Europe’s illiberal transformations. The broader point here, one that I do not have the space to develop in this book, is that the “variety of capitalisms” literature needs to consider the role of political accountability in enhancing the quality of state-society interaction. Rather than a simple dichotomy between a liberal market economy and a coordinated market economy, analysts should include a second political dimension that analyzes the degree of accountability constraining the state-society nexus (for more, see Hall and Soskice 2001; also, compare Stark and Bruszt 1998 and McDermott 2007 with the Ukraine and Slovak case studies in this book; for a good comparison of Poland and Ukraine, see Mykhnenko 2005, 2009). 16. For one, democratic postcommunist states were closer to Western markets and capital. Andrew Schwartz argues that this proximity—and the clear opportunities it creates—generate a larger postprivatization constituency in favor of liberal change (2006: 6–8; see also Kopstein and Reilly 2000). 17. Defined by Hoff and Stiglitz as “stripping the assets of the enterprise, appropriating corporate value for themselves, whisking capital to a safe place, and letting the capital stock wear out” (2005: 6). 18. A number of countries chose mass-privatization schemes, which quite typically resulted in poor corporate management. Advocating agents before institutions, neoliberals sought to facilitate rapid transfer to a group of second owners with clear control over their firms. While neoliberals see the need for corporate governance, many policy practitioners resisted reform in corporate governance to ensure the faster emergence of a second group of owners with clearer control over their assets (see Chapter 5).

Chapter 4 1. Planners initially sought to establish the credibility of the new regime through a surge of imports, increased infrastructural investment, and consumption. Consumption, however, was ratcheted back in the 1970s. In contrast to Poland and

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Hungary, Czechoslovakia never fell into significant debt to Western banks (see also Stevens 1985: chapter 6; Teichova 1988: 166–170). 2. Interview with Jozef Ku¸cerák, Bratislava, Slovakia, January 13, 1997; interview with Jozef Uhrik, commercial director, Volkswagen Slovakia, Devinska Nová Ves, Slovakia, January 14, 1997. 3. Interview with Jozef Uhrik, January 14, 1997; interview with Anton Furgalak, director, Atriem, s.r.o., Žilina, Slovakia, July 22, 1998; interview with Stefan Marsina, special assistant to the general director, Považské strojárne, a.s., Považská Bystrica, Slovakia, July 22, 1998. 4. Idealized conceptions of tripartite negotiations portrayed government, business, and labor sitting down at the table to distribute the costs of industrial restructuring. To work, however, the negotiators must have the power to discipline their movements—hence the emphasis on creating peak organizational structures that could negotiate for an entire sector or even class. 5. Valtr Komárek established the Prognostics Institute (formally known as the Institute of Forecasting) within the Czechoslovak Academy of Sciences in the mid1980s. Komárek’s own personal ties within the party and the increasing tendency of Prague’s conservative leaders to take their cues from Moscow’s ongoing program of perestroika and glasnost gave institute members the space to work on reform concepts with relative safety and independence. Of the wide range of economists who entered the government or rose to professional prominence following the Velvet Revolution, a significant number emerged from Komárek’s institute, including, most notably, his deputy directors, Vladimír Dlouhý and Václav Klaus, but also Otakar Turek, Karel Kouba, Lubomír Ml¸coch, Dušan T¸riska, and the Slovak economist-turned-nationalist Jozef Markuš, just to name a few. 6. Ian Traynor, “Prince of Prague,” The Guardian, November 3, 1994, p. T4. 7. Interview with Otakar Turek, economist, Prague, Czech Republic, May 27, 1997. 8. “Financial Reform in Czechoslovakia: A Conversation with Václav Klaus,” Financial Times, February 20, 1990, p. 77. 9. The team included Václav Klaus; Vladimír Dlouhý; Dušan T¸riska; Tomáš Ježek; the Slovak economist Vladimír Rudlov¸cák; Josef Tošovský; Ivan Ko¸cárník; and, finally, another of Klaus’s former Prognostics Institute colleagues, Karel Dyba. 10. The team included, most notably, František Vlášek, Otakar Turek, Karel Kouba, and Lubomír Ml¸coch. 11. Interview with Otakar Turek, May 27, 1997. 12. Ibid. 13. Both Kouba and Turek attribute this to the strength of Klaus’s ideas and personality. As Turek pointed out, Klaus was an extraordinarily forceful and arrogant advocate of his own policies. He had, above all, a domineering personality accompanied by what Turek best described as “deep egocentrism. . . . [Klaus is] convinced deep in his head that what he thinks is genius.” Interview with Otakar Turek, May 27, 1997; interview with Karel Kouba, Institute of Economic Studies, Charles University, Prague, Czech Republic, June 25, 1997. 14. Vlášek insisted that the body be called the Ministry for the Administration of National Assets, thus emphasizing the team’s view that property be prepared by the state before privatization. Ježek refused to accept the title until Vlášek allowed him to tag “and its Privatization” at the end. Hence the final name of the ministry:

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Ministry for the Administration and Privatization of National Assets. Ježek later recalled, “It’s a pretty stupid name, isn’t it? But it precisely expressed the political fight over the character of reform” (Husák 1997: 111). 15. Anthony Robinson, “Czech Attack on Market Socialism,” The Financial Times, March 26, 1991, p. 20. 16. FBIS-EEU, February 1990. 17. Mladá fronta dnes, February 25, 1992, p. 1, as cited in Appel 1998: 97. 18. Interview with Martin Palouš, Center for Theoretical Study, Charles University, Prague, Czech Republic, May 25, 1997. Even as Klaus was attacking communist and left-leaning ideas and institutions, he nevertheless was not opposed to working closely with ex-communists who were useful to him. As former Klaus associate and outspoken critic Tomáš Ježek told Hilary Appel, “Klaus was ‘anti-’ the communist system. And he was ‘anti-’ certain people, but because they disagreed with him, not because they had been communists” (Appel 1998: 221). 19. Interview with Jan Mládek, director, the Czech Institute of Applied Economics, Ltd., Prague, Czech Republic, June 26, 1997 (see also Šiklová 1996: 57– 62). The lustration law was an anticommunist screening measure passed in October 1991 that barred the bureaucratic and industrial elite from certain top state posts for past acts of political collaboration with the communist secret police (STB) (Cepl 1994). 20. Klaus’s academic opponents made a number of objections questioning the economic efficiency of an untested mass privatization program. Who would really control these firms if they had thousands of owners? What would be the attitude of owners to property they had received for free? What would the secondary market for shares look like? Interview with Karel Kouba, June 25, 1997; interview with Lubomír Ml¸coch, dean, Faculty of Social Sciences, Charles University, Prague, Czech Republic, April 9, 1997; for his critique of voucher privatization, see Ml¸coch 1997a: 3–14. 21. Interview with Vladimír Rudlov¸cák, state secretary, Ministry of Finance, Prague, Czech Republic, July 24, 1997. 22. Ibid. 23. Klaus’s electoral victory in 1992 allowed him to replace Jan Vrba with the more market-reform-oriented economist Vladimír Dlouhý. Yet Dlouhý and Klaus pursued a passive industrial policy in the form of soft-bank credits to troubled state-owned firms. Interview with Jan Vrba, consultant, Prague, Czech Republic, June 1994. 24. Klaus was against the physical restitution of property to its previous owners or their descendants, correctly predicting that the ensuing court proceedings would delay the transfer of assets for years. He lost this battle to a coalition of gradualists and former dissidents who insisted on the physical return of property. Interview with Ji¸rí Šebánek, senior manager, International Organizations Division, Czech National Bank, Prague, Czech Republic, July 25, 1997. 25. Jan Svejnar’s original proposal is found in Svejnar 1989; for a full technical discussion of the program as passed by federal parliament in February 1991, see Ministry of Finance, CSFR 1992: 5–38. 26. Interview with Vladimír Rudlov¸cák, July 24, 1997. 27. Ibid. 28. Indeed, in fall 1990, Klaus and his cohort T¸riska did a whirlwind tour of enterprises arguing for their cooperation on this basis (Appel 1998: 97).

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29. Interview with Vladimír Rudlov¸cák, July 24, 1997. 30. Interview with Jozef Uhrik, January 14, 1997; interview with Anton Furgalak, director, Atriem s.r.o., Žilina, Slovakia, July 22, 1998; interview with Stefan Marsina, July, 22 1998. 31. Stephan Hrib, Pravda, July 9, 1993, as cited in Brzica 1996: 8. 32. Interview with Jozef Uhrik, January 14, 1997. 33. Interview with Jozef Markuš, president, Matica Slovenská, Bratislava, Slovakia, January 15, 1997. 34. Another prominent Slovak economist not mentioned here is Augustine Marián Húska, Me¸ciar’s first minister of privatization. Unlike Filkus, Húska’s national sentiments were not tempered by a conviction of the need for liberal economic reforms. 35. Interview with Rudolf Filkus, member of Parliament, Bratislava, Slovakia, April 15, 1997. Prior to the elections of June 1990, Filkus had briefly been at the Economics Institute of the Slovak Academy of Sciences. Before that, he had held various research positions in Slovak academies and the planning bureaucracy. 36. Interview with Jozef Ku¸cerák, January 16, 1997. The new federal government offered Jozef Markuš a position as head of the federal Anti-Monopoly Office, but it withdrew the offer as allegations surfaced that he may have at some point collaborated with the former communist secret police (STB) (Marcin¸cin, Zemanovi¸cová, and Vaga¸c 1996: 8). 37. Interview with Jozef Ku¸cerák, January 16, 1997. 38. “Slovak Claim,” The Independent, April 6, 1990. 39. Interview with Jozef Markuš, January 15, 1997. 40. This tension in the government program declaration did not go unremarked. As the Green Party’s Mikuláš Huba noted, “the dominating principles are economically one-sided, representing notions like substantial material growth of wealth, economic prosperity, privatization, and so on . . . the program is inconsistent with the spiritual principles of the gentle revolution. Rather, its immediate provisions smoothly contradict them” (Žiak 1998). 41. Interview with Rudolf Filkus, April 15, 1997; Marta Moricova, “The Government Must Protect Citizens,” Narodná obroda, November 16, 1990, p. 3. 42. Igor Zvach, “The Devaluation Brings Problems,” Narodná obroda, January 3, 1991, p. 3. 43. Marta Moricova, “Social Repercussions: A Priority,” Narodná obroda, January 3, 1991, p. 3. 44. Interview with Jozef Ku¸cerák, January 16, 1997. 45. Interview with Miroslav Šedlak, president, NEZES, Bratislava, Slovakia, March 10, 1997; italics added. 46. Ibid. 47. Association of Independent Slovak Economists (NEZES), “NEZES: K reforme a hospodárskej nezávislosti Slovenska,” Hospodá¸rske noviny, March 18, 1991, p. 3; italics added. 48. KDH, “Alternatívy dalšieho postupu ekonomickej reformy,” Hospodá¸rske noviny, March 19, 1991, p. 4. KDH’s statement reflected its own internal divisions. The document was largely the work of nationalist elements within KDH, notably led by the former communist-era industrial official Viliam Oberhauser. These politicians would later break off to form the Slovak Christian Democratic Movement (SKDH) in the run-up to the 1992 election. After SKDH broke away, Ján

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¸ arnogurský, then prime minister, took a relatively strong profederal line in both onC going jurisdiction and economic reform issues. ´ udovít Cernák, ¸ 49. Interview with L member of Parliament, Bratislava, Slovakia, April 2, 1997. ¸ 50. Zoltan Bergauer et al., “Petice svazu pr u˚ myslu CR a SR Federálnimu ¸ shromážd¸ení CSFR,” Hospodá¸rske noviny, February 29, 1991, p. 3. ´ udovít Cernák, ¸ 51. Interview with L April 2, 1997. 52. Stra¸cár only adopted the VPN name later—indicating a somewhat reluctant alignment with the Bratislava revolutionary movement. 53. Interview with Milan Šútovec, chair, Slovak Writer’s Association, Bratislava, Slovakia, March 24, 1997. 54. “Slovak Meeting Studies Economic Problems,” FBIS-EEU, August 17, 1990, p. 8. 55. Various expressions of industry frustration and disgust frequently broke out into the open in angry, bitter accusations. After being forcibly retired, for example, the former general director of the tank producer ZTS Martin referred to the end of the Cold War as an “unusually unfavorable development in the international political situation.” Herbert Durkovic, “We Have Broken up the Most Successful Czechoslovak Engineering Complex: Myths About the Martin Heavy Engineering Works and the Reality,” Narodná obroda, January 7, 1991, p. 13. 56. Jozef Ku¸cerák, “The Christian Democratic Movement: With Us or on Their Own?” Verejnost, February 20, 1991, p. 3. ¸ 57. Igor Cibula, “Merely an Unusual Agreement with Carnogurský?” Narodná obroda, February 26, 1991, p. 3. 58. “Televízny prejav Milana K¸nažka z 3. marca 1991,” in Antalová 1998: 340– 341. 59. “Me¸ciar Interviewed on VPN Split,” FBIS-EEU, March 11, 1991, pp. 22– 23. 60. Excerpts from Prime Minister Vladimír Me¸ciar’s speech to the VPN Assembly, FBIS-EEU, March 1, 1991, pp. 11–12. ´ udovít Cernák, ¸ 61. Interview with L April 2, 1997. 62. Mikloš, who was responsible for implementing voucher privatization in the face of AZZZ opposition, does not provide corroborating evidence on this; nor was the Association of Employers Unions willing to provide any corroborating information (Mikloš 1997: 60). 63. All parties advocated greater Slovak autonomy in dealing with the economic transition. However, the rump VPN party (VPN/ODU) was the most vociferous in defending the federal concept of reforms (Innes 1997: 411–412).

Chapter 5 1. Interview with Lubomír Ml¸coch, April 9, 1997. 2. Interview with Vladimír Rudlov¸cák, July 24, 1997. 3. Ibid.; Interview with Lubomír Ml¸coch, April 9, 1997. 4. Interview with Vladimír Rudlov¸cák, July 24, 1997. 5. Ibid. 6. Peter Holub, “Kde se stala chyba,” Respekt, June 23–29, 1997, p. 26.

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7. Interview with Vladimír Rudlov¸cák, July 24, 1997. As Rudlov¸cák added, “he showed the way how to [make the voucher program work], but he . . . did in no way save privatization.” 8. Interview with Ji¸rí Šebánek, July 25, 1997. 9. “Bankruptcies? . . .” FBIS-EEU, October 23, 1992, pp. 5–7. 10. In contrast to Schütte (2000), Capek and Mertlík (1996) found little evidence of political pressure on banks in decisions involving ten Czech firms. Yet the overall record appears to support Schütte. Raj Desai (1995) charts how the government used funds from the Fund for National Property to prop up the financial system as it doled out loans to poorly performing firms that had been turned over to the Czech Ministry of Industry and Trade—a form of passive industrial policy. Similarly, Lízal and Svejnar (2002) show how soft loans from state banks increased at the start of the 1996 recession. ¸ 11. The share price of Komer¸cní banka and Ceská spo¸ritelna, the country’s first and second largest banks, plummeted from 2,085 K¸cs (US$77) to 333.10 K¸cs and from 312 (US$11) K¸cs (US$11.50) to 83.97 K¸cs (US$3.75) respectively between December 1996 and December 1998. Ron Leuty, “CS Woes Bind Banks to State, Industries,” The Prague Post, December 9, 1998. 12. Amendments to the Law on Collective Investment in 1996 issued even tighter restrictions on IPFs with the intention of forcing them to behave more like portfolio funds and less like owners. Firms responded by transforming themselves into enterprise holding companies (Kenway and Klvacová 1996: 805). 13. Interview with Vladimír Rudlov¸cák, July 24, 1997; interview with Jan Daros, Legal Department, and Miloš R˚u ži¸cka, spokesman, National Property Fund, Prague, Czech Republic, July 23, 1997. According to Daros, the Fund retained the right to repossess its shares if the recipient did not meet its privatization contract, but in reality, the FNM often discovered that by the time it pressed its legal claims in the courts, the assets of the privatized company had been tunneled to other entities. 14. For additional evidence on the discounts of bank-owned funds, see Claussens 1997. Similarly, more concentrated fund ownership in 1993 was associated with a marked decline in disclosure in annual reports indicating a preference for the “private benefits of control over increases in share prices”; see Coffee 1996; Makhija and Patton 2004: 486. Another problem was insider trading. There was supposed to be a formal firewall, for example, between bank and fund management, but in practice, bankers and fund managers often combined their proprietary knowledge of firms to engage in insider trading. Again, the capital markets regulators appeared unable or unwilling to fully enforce the rules that were in place. See OECD 1994: 86; Schütte 2000: 267–268. 15. According to the World Bank, the net profitability of Czech Enterprises decreased from 8.0 percent of GDP in 1994 to 4.6 percent in 1996 (1998: 35). 16. This is an expanded version of the case study that appears in Appel and Gould 2000: 121–123. 17. At the time the IOC consisted of Total, Agip, Conoco, and Shell. Total later dropped out. 18. Interview with Ales Soukop, spokesman, International Oil Companies negotiating team, Prague, Czech Republic, January 11, 1995. 19. Interview with Jan Mládek, June 26, 1997. 20. Interview with Pavel Mertlík, July 1997; see also Hayri and McDermott

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1995; McDermott 1997; Stark and Bruszt 1998. In the first wave of privatization, Chemapol set up an investment privatization company, Expandia Funds, to participate in the competition for voucher points. Through an aggressive marketing campaign, Expandia’s six funds had attained a K¸cs 5 billion (US$172 million) portfolio by the end of the second wave of privatization. Expandia also purchased many shares directly from the National Property Fund indirectly financed by generous lending from state-owned banks. In 1995, Chemapol’s management transferred 90 percent ownership of this fund from the corporation to themselves. In the same year, Chemapol went on a long, leveraged buying binge on capital markets, producing a final portfolio worth about 40 billion K¸cs (US$1.5 billion). By 1995 the combined Chemapol group had revenues of about 4.5 percent of GDP, exports and imports of around 4 percent of foreign trade—including 35 percent of foreign chemical trade. In addition, Chemapol Group could use its position as the supplier and buyer of its partially owned subsidiaries to transfer profits into its wholly owned trading company (ING Barings 1996). ¸ 21. CTK Business News, May 27, 1994. 22. Mladá fronta dnes, July 27, 1994. For a contemporary rehash of this argument, this time implicating Klaus, see Gregg Feifer and Brian Whitmore, “The Velvet Surrender: Russia Reconquers the Czechs,” The New Republic, September 17, 2010. ¸ 23. CTK National News, August 5, 1994. ¸ 24. CTK National News, August 11, 1994. 25. The Czech way did not disappear in 1995. In the subsequent privatization of the Czech telecom sector, the incumbent Czech managers raised the topic but were almost immediately countered by vehement commitment to foreign participation by the minister of the economy, Karl Dyba. Jennifer Hushion, “Foreign Investors Wary of the ‘Czech Way’ After Tender Confusion,” Central European Business Weekly, January 6–12, 1995, p. 1. 26. Interview with Jan Müller, custody manager, Commerzbank, Prague, Czech Republic, June 17, 1997; Müller was a Ježek protégé, who later became director of the Czech Securities Exchange Commission. 27. Interview with Ji¸rí Šebánek, July 25, 1997. 28. Interview with Vladimír Rudlov¸cák, July 24, 1997. 29. Interview with Jan Müller, June 17, 1997; interview with Ji¸rí Šebánek, July 25, 1997. 30. Interview with Pavel Mertlík, July 1997. 31. Terrence Petty, “Czech Republic: Investors Worried as Swindlers Outwit Regulators,” Associated Press, April 14, 1997. 32. Interview with Jan Müller, June 17, 1997.

Chapter 6 1. Mikloš recalls that the ministries of Forest and Water, Agriculture, and even the Environment—all run by KDH appointees—had strong gradualist leanings. Interview with Ivan Mikloš, April 2, 1997. 2. Mikloš’s first post was as Ku¸cerák’s advisor and director of the government’s Section for Economic and Social Policy. Interview with Ivan Mikloš, consultant, M.E.S.A. 10, Bratislava, Slovakia, October 1, 1996.

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3. In about sixty cases, managers called for direct sale to themselves exclusively. Assuming that the managers had failed to meet their obligation under the Privatization Act to make important data available to competitors, Mikloš reopened the proposal submission process for an additional two months and pushed the firms to provide the necessary data to competitors. Interview with Ivan Mikloš, October 1, 1996; Mikloš 1995. ´ udovít Cernák, ¸ 4. Interview with L April 2, 1997. 5. Interview with Ivan Mikloš, April 2, 1997. 6. Rudolf Lachovi¸c, “Vzt’ah kupónovej metódy privatizácie a kolektívneho investovania,” Global Brokers, Bratislava, Slovakia, 1997, manuscript. 7. Interview with Ivan Mikloš, April 2, 1997. T¸riska recalls being surprised at the strong support for the voucher scheme in Slovakia (T¸riska 1991a: 26; T¸riska 1991b). 8. Dolgoš stressed that any efforts to set voucher privatization timelines or the volume of assets to be voucher privatized in advance “would . . . fail to serve a purpose.” Dolgoš’s reformulated concept even warned industrial managers that if their second-wave base privatization plans relied too heavily on the voucher method, they would be “subjected to particularly critical and thorough evaluation.” There would also be a critical “assessment of the risks derived from concentration of ownership through privatization investment funds.” Instead, Dolgoš emphasized “combined methods” in which management buyouts would play an “exceedingly important role.” Ministry of Administration and Privatization, SR 1992. Interview ´ ubomír Dolgoš, March 20, 1997. with L 9. Interview with Ivan Mikloš, April 2, 1997. ´ udovít Cernák, ¸ 10. Interview with L April 2, 1997. ´ ubomír Dolgoš, member of the Faculty of Management, 11. Interview with L ´ uEconomics University, Bratislava, Slovakia, March 20, 1997; interview with L ¸ dovít Cernák, April 2, 1997. 12. Slovakia’s president was constitutionally weak. Executive power flowed from parliament with limited presidential powers to check it. Ková¸c could and did veto legislation and appointees, but parliament could override this with a mere majority. Later, when parliament deadlocked over a new presidential candidate, presidential powers—including the power of a presidential amnesty—transferred to Prime Minister Me¸ciar. 13. Another 50 percent was spread across a wide range of funds and individual shareholders, leaving the FNM, with its residual 37.6 percent, effectively in charge (Olsson 1999: 223). 14. “Me¸ciar Accuses Opposition of Links with 21 Major Companies,” Slovakia, February 6, 1994. 15. Confidential interview, Slovnaft insider, Bratislava, Slovakia, February 1997. 16. “Strong in the Saddle,” Slovakia, February 11, 1994. 17. “Me¸ciar Accuses Opposition of Links with 21 Major Companies,” Slovakia, February 6, 1994. ¸ 18. “Former Members of VSŽ Board Lodge Complaint,” CTK Business News, March 21, 1994. 19. Despite Tóth’s allegations against Berghauer, no charges were ever filed against him. 20. Anthony Robinson, “Survey of Slovakia,” The Financial Times, December

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16, 1994, p. iv. It is unlikely that Tóth was genuinely outraged at the allegations of corruption at VSŽ. In 1993, he had allegedly used his influence as minister of finance to give a trading company, VSŽ Selecta, a state contract to sell sugar that the Indian government provided to the Slovak government in place of its cash debt. Critics allege that VSŽ Selecta won the contract without the required tender and then sold the sugar on the world market in violation of its contract. Tóth was a mem¸ ber of the company’s board. “Report on ‘Sugar Affair’ to Be Out in January,” CTK News, December 5, 1993. ¸ 21. “Approach to VSŽ Privatization ‘Strange and Unusual,’” CTK Business News, May 3, 1994. Me¸ciar attempted to establish Banka Slovakia as early as 1993 in his home region of Banská Bystrica as part of his effort to develop a regional banking center there. The goal was to use the bank to recycle FNM funds and provide cheap credit for small to medium-sized enterprises. After the VSŽ deal, however, the opposition charged that it would be used as a means of providing the politically connected with cheap capital to make down payments for privatization deals. The next government suspended the bank’s license to operate in April 1994. With Me¸ciar’s reelection in the fall, the government pushed the National Bank of Slovakia to grant the license. But after building a costly and elaborate headquarters in Banská Bystrica and suffering from notoriously poor lending practices, the bank had significant difficulties with capitalization. The NBS finally approved a license to begin operating on June 1, 1996, but the bank—like most Slovak banks—quickly developed a problem with nonperforming loans. ¸ 22. “Approach to VSŽ Privatization ‘Strange and Unusual,’” CTK Business News, May 3, 1994. Tóth also became deputy chairman of Priemyselná banka (Olsson 1999: 223). 23. Interviews with Milan Jani¸cina, commercial lawyer, Bratislava, Slovakia, March 10, 1997; April 1, 1997. 24. Interview with Rudolf Filkus, April 15, 1997. Interviews with Milan Jani¸cina, March 10, 1997; April 1, 1997. 25. Interview with Milan Jani¸cina, April 1, 1997. ¸ 26. In spring 1993, Me¸ciar had helped Ján Slota oust Cernák from control over ¸ the SNS. Cernák left (with Jani¸cina) to form the Democratic Union (DU). Inter´ udovít Cernák, ¸ view with L April 2, 1997. 27. Interview with František Bruckmeyer, general director, Federation of Employers Unions and Associations (AZZZ), February 6, 1997. Prior to becoming director of AZZZ, Bruckmeyer worked for the Czechoslovak federal government after the Warsaw Pact invasion (1970–1974) and the Council of Mutual Economic Assistance in Moscow (1974–1980). In the 1980s, he directed the state-owned firm Zdroj before cofounding AZZZ in 1991. Compiled from Leaders.sk database, Trend Holding Co., and The Slovak Spectator, Bratislava, Slovakia; http://www .leaders.sk/index.php?id=674. 28. Both Article 17b of the Universal Declaration of Human Rights (United Nations General Assembly 217/1948) and Protocol 1, Article 1, of the European Convention on Human Rights (Council of Europe 1952) secure the right to possessions. 29. In fall 1997, Parliament finally gave in to EU and opposition pressure and appointed Ivan Mikloš to the supervisory board of FNM. ¸ 30. CTK News, May 8, 1998. Me¸ciar was never directly implicated in a privatization scandal while in power (Fisher 2006: 91).

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31. Rudolf Lachovi¸c, “Vzt’ah kupónovej metódy privatizácie a kolektívneho investovania,” Global Brokers, Bratislava, Slovakia, 1997, manuscript. 32. The administration may have legitimately feared that privatization would mean the services of the spas would no longer be readily available or affordable to average Slovaks through the health care system. 33. Interview with Gabriel Palacka (KDH), MP, Slovak National Council, Bratislava, Slovakia, April 18, 1997. 34. The regional meetings were an institutional mechanism for regionally based privatization groups to make their claims to property. In the eyes of observers, the groups became associated with leading HZDS officials and clients. For example, it was rumored that meetings in Košice tended to be dominated by Režes, those in Banská Bystrica by Me¸ciar, and those in Trnava by Vladimír Poor. Interview with Valér Ostrovsky, CEO, Schultz and Ostrovsky, Bratislava, Slovakia, May 14, 1997. 35. Marek Vagovi¸c, “Gavorník: Za privatizáciou Nafta Gbely stál Gašparovi¸c,” SME, May 9, 2009, p. 3. 36. Ibid. 37. Author’s notes from “Slovak Spectator Live, Debates for Democracy Series: Brigita Schmögnerová & Ján Ducký,” Bratislava, Slovakia, 1996. An FNM spokesman shared this sentiment with the author in an interview. Interview with Oto Balogh, press spokesman, Fund for National Property, Slovak Republic, Bratislava, Slovakia, April 22, 1998. 38. Marek Vagovi¸c, “Gavorník: Za privatizáciou Nafta Gbely stál Gašparovi¸c, SME, May 9, 2009, p. 3. 39. Interview with Oto Balogh, April 22, 1997. 40. Confidential interview with foreign financial service executive, Bratislava, Slovakia, October 20, 1996. Most of the foreign financial service executives and consultants I spoke with had similar stories. 41. Magula claims that as a result of his parliamentary testimony, he came under AZZZ pressure to step down. He relented and moved to the central bank. Interview with Jozef Magula, member of the board, General Relations Department, National Bank of Slovakia, Bratislava, Slovakia, July 28, 1998. 42. Interview with Jozef Magula, July 28, 1998; interview with Rudolf Lachovi¸c, president, Association of Investment Managers and Investment Funds of the Slovak Republic, Bratislava, Slovakia, June 16, 1997. For early market regulatory climate, see Juris 1994. 43. Interview with Valér Ostrovsky, May 14, 1997. 44. Interview with Vladimír Hoffman, broker, Delta Securities, Prague, Czech Republic, July 25, 1997. 45. Interview with Jozef Magula, July 28, 1998; interview with Valér Ostrovsky, May 14, 1997. 46. The Helsinki Civic Assembly and the Association for the Support for Local Democracy survey concluded that state-run Slovak Television violated the principles of fairness more often than any other public or private media outlet during the 1998 electoral campaign. It devoted 75 percent of its news programs to Me¸ciar and HZDS, RFE/RL Newsline, 2:192, October 5, 1998, Part II. 47. J. M. Viersma, “Správa docasnej pozorovatelskej misie na Slovensku,” Euro Report, no. 15, 1998, pp. 22–23. 48. For example, the author interviewed an industrial manager who had recently signed a contract to produce copper pipes for a firm in Germany. When the day

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came to buy scrap metal to begin production, however, the cash he had reserved for the purpose had disappeared, and he had to default on the contract. He soon learned that the owners had moved the funds to a short-term security with a return far greater than that offered by the copper pipe contract. Interview with Stefan Marsina, July 22, 1998. 49. Indeed, one EU-sponsored consultant that I spoke with actually advised his clients to engage in a similar triage strategy of debt management. Specifically, he advised managers facing illiquidity to delay paying those creditors who were no longer essential to the firm, while using scarce cash to meet obligations to those creditors who were. The understanding was that the legal framework would favor the debtor. Confidential interview, foreign financial consultant, Bratislava, Slovakia, April 1997. 50. Interview with Oto Balogh, April 22, 1997. Ironically, the politicization of credit and debt may have meant that the incentives to rip off stakeholders and minority shareholders were greater for owners who did not enjoy close contacts with the government. Unlike their well-connected competitors, they were not likely to win any dispensations from government creditors at the state-owned banks, the FNM, or the tax officials. 51. The government also set up a state-run arms trading company, Armex. 52. Interview with Ministry of Economy plenipotentiary for the automotive industry in Slovakia, Alfred Richter, in Samuel Bibza, “Velké Plány,” MOT, August 1998, pp. 4–8; interview with Ján Lešinský, president, Slovak Society of Automotive Engineers, Bratislava, Slovakia, August 10, 1998. 53. If we include the third state-owned financial institution, Slovenská sporitel¸na, these three banks accounted for as much as 90 percent of all Slovak deposits and 60 percent of all loans (EIU 1998: 17; OECD 1998: 29). 54. In spring 1998, VSŽ used its influence with FNM and its direct and indirect shareholdings in the two other state financial institutions to provide the IRB a costly capital injection. VSŽ again refused to contribute any cash of its own beyond the initial amount required by the NBS. Nor was there any real attempt by VSŽ to find an adequate foreign buyer. Peter Laca, “Troubled IRB Bank Approves Capital Injection,” The Slovak Spectator, May 7–21, 1998. 55. “Vláda mimo hry,” Pravda, November 17, 1998; see also Mikloš 1997. 56. Confidential interview with FC Slovan football player, Bratislava, Slovakia, July 1998. 57. “Another Agency Downgrades Slovakia’s Risk Indicator,” The Slovak Spectator, May 7–21, 1998, p. 5. 58. M.E.S.A. 10, Slovak Monthly Report, May 1998, pp. 1–2; M.E.S.A. 10, Slovak Monthly Report, July 1998, p. 2. 59. Interview with Ferdinand Petrák, vice chairman, Party of Civic Understanding (SOP), Bratislava, Slovakia, July 28, 1998.

Chapter 7 1. Discussion with Pavol Demeš, German Marshall Fund, Colorado Springs, CO, November 16, 2009. 2. To refresh our memories, this book employs Levitsky and Way’s definition

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of a “competitive authoritarian regime” to distinguish between the family of liberal competitive democracies and their illiberal cousins. Competitive authoritarian regimes retain the formal political institutions of democracy, but their actual practice constrains competition to give incumbents an insurmountable advantage. While enough political space exists for oppositions to form and contest for power, if opponents adhere to the formal and informal rules of the game, it is extraordinarily unlikely that they will win (Levitsky and Way 2002). 3. Political competition theorists fully expect comparative authoritarian governments to produce short-term booms through fiscal extravagance, e.g., Slovakia in 1996–1998. Ultimately, however, such booms are short-lived, particularly when resources are not invested in restructuring to generate long-term productivity increases. 4. Perhaps the best studies of this topic take place in countries following liberal postcommunist pathways like Poland, Czech Republic, and Hungary (McDermott 2002, 2007; Stark and Bruszt 1998). Few efforts have been made to systematically theorize about how similar institutionalized state-business network deliberation plays out under more authoritarian conditions (for a partial exception, see Mykhnenko 2005). 5. Although this too is controversial. For a good introduction to the “Asian development debate,” see Berger and Beeson 1998. 6. Kuchma was actually Kravchuk’s second prime minister following the relatively unproductive government of Vitold Fokin. 7. In the Ukraine context, the term clan is pejorative. From here on I use the term networks. I will reserve the term clans for the next chapter, where it more accurately refers to identity-kinship-based networks. 8. The trick was to have access to a commodity or a currency that would hold its value while the asset borrowed lost purchasing power due to inflation. Debtors could borrow money from the state and use it to buy a commodity or foreign currency. When the original debt came due, they could use a fraction of their borrowed assets to buy back into the local currency and pay off the original debt. The commodity or currency remaining in their hands was rent. For more on the mechanics of such scams in the Russian context, see Shleifer and Treisman 2000: 39–52. 9. The former helped certificate holders gain direct shares in companies, while the latter issued its own shares in exchange for vouchers. Legislation limited the stake in a firm that intermediaries could gain, however. 10. Another popular mode of privatization was to allow employees to use enterprise profits to acquire equity in the company, which was then distributed among employees according to seniority. Equity prices were set at fixed nominal levels that became increasingly affordable as inflation eroded their real value. These programs transferred thousands of small enterprises and many medium enterprises into private hands. A number of other methods were used, but Pivovarsky’s sample only accounted for a fraction of the total shares transferred. Combined, by contrast, the methods described here accounted for just under 60 percent of the equity of the 363 firms sampled (Pivovarsky 2003: 29–30). 11. Roman Kupchinsky. “Problems in Ukraine’s Coal Industry Run Deep,” RFE/RL, February 9, 2005, http://www.rferl.org/content/article/1057371.html. 12. One source half joked that the last straw for Yushchenko’s opponents was the prime minister’s order limiting the cost of a government car to less than $95,000, effectively preventing top government officials from acquiring even the most basic

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Mercedes S600 luxury cars. Hetman’s interview with Alex Haponiev, Wisconsin University, Kyiv, Ukraine, July 2006. 13. Following her release, Tymoshenko led moderately sized demonstrations against the regime in what Andrew Wilson has labeled the first “dress rehearsal” for the Orange Revolution—the second followed the 2002 parliamentary elections. Wilson 2005: chapter 4. 14. In 2003, I met with representatives of the US Congressional NGOs, the National Democratic Institute (NDI), and the International Republican Institute (IRI). In the middle of my NDI interview, conducted in a subterranean café, a gentleman at the table next to us pulled out some sort of personal digital assistant and laid it flat on the table. When we appeared not to notice, he took out a large camera and photographed me. Perhaps I was paranoid, I thought later. But when I returned the following summer to meet with a representative from the IRI—this time at an outdoor café—a gentleman again took the next table upon which he positioned an impossibly large briefcase. Lest we should miss him, he was dressed in a bright orange jumpsuit. I expect this was to help me recognize him when he followed me down the road after the interview. Such harassment, albeit harmless, was probably part of an effort to irritate IRI, NDI, and the US Congress. Among other measures in this campaign, Medvedchuk’s State Administration refused to reregister IRI and NDI as NGOs— forcing them to work on an informal basis. This, in turn, was a significant irritant on both sides of the aisle in Congress. According to IRI’s Brian Medford, Medvedchuk had presidential aspirations and was seeking to embarrass Viktor Yanukovych, the prime minister, who was correctly seen as the leading candidate to replace Kuchma in the upcoming presidential election. The hope may have been that the White House would cancel Yanukovych’s planned state visit. If so, the strategy worked: the planned meeting never happened. Gould’s interview with Brian Medford, International Republican Institute, Kyiv, Ukraine, July 18, 2003; Gould’s interview with Jeannie Kugel, National Democratic Institute, Kyiv, Ukraine, January 8, 2003. After the Orange Revolution, I ran into an NDI veteran from Kyiv. Allegedly, he had recently met with a former Ukrainian state security officer who joked, “Yes, it’s true. We tapped all your phone calls, read your emails, and listened to your conversations. But you’ll be happy to know we were six months behind in transcribing the information.” The source who told me this anecdote would not confirm it for me for this publication. It may simply be an internal NDI legend. 15. Other factors contributed to the repatriation. Kuchma’s greater control and an informal amnesty on laundered money helped him entice the oligarchs into returning their funds. Meanwhile the US conviction of Lazarenko for embezzlement and a toughening of financial oversight made most foreign capital havens look less promising. Hetman’s interview with Volodymir Martenyuk, Slax Peremogu, Kyiv, Ukraine, June 2006; Gould’s interview with Volodomyr Sidenko, director of Economic Programs, Razumkov Centre, Kyiv, Ukraine, July 17, 2003. 16. Interview with Volodomyr Sidenko, July 17, 2003. 17. Hetman’s interview with Igor Shpak, advisor for Governmental Finance, International Monetary Fund, Kyiv, Ukraine, June 2006. Åslund estimates it was about 2–3 percent of GDP (2009: 167). 18. The Value Added Tax (VAT), or PDV in Ukrainian, is a tax on the value added to a good before it is resold for a higher amount of money. To encourage exports, the Ukrainian government refunded the VAT to the person or entity that exported a good.

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19. Interview with Igor Shpak, June 2006. 20. Interview with Volodymir Martenyuk, June 2006. 21. Hetman’s interview with Yuriy Chuikov, general manager, Alternet Telecommunications, Kyiv, Ukraine, June 2006. 22. Hetman’s confidential interview with high-ranking official, Ukrainian Border Guards, Ukraine, June 2007. 23. “The Disparity Between Ukraine and Poland’s Export Statistics Amounts to $800 Million in 2008,” Ukrainian Independent News Agency (UNIAN), March 11, 2004. 24. For the most comprehensive discussion of illiberal Kuchma-era measures, see D’Anieri 2007: 192–207. 25. Melnychenko was President Kuchma’s bodyguard. The tapes purported to record Kuchma nudging subordinates to get rid of journalist Heorgiy Gongazde, among other things. 26. With the exception of the Social Democratic Party of Ukraine (SPDU) and a few others (e.g., Block of Yulia Tymoshenko–BYuT, pronounced “beauty” by supporters), scholars of Ukrainian politics generally do not use abbreviations for Ukrainian parties. Perhaps this is because the names of most parties do not indicate their programs—reflecting the personal/client character of political parties that serve as political vehicles of individuals and regions. 27. According to D’Anieri, “precincts with hospitals, army bases, and prisons provided some of the highest electoral returns for Kuchma. The phenomenon was so widespread that the pro-Kuchma bloc Za Yedinuu Ukrainy (For a United Ukraine) was given the nickname Za Yed-U (For Food)” (2003: 62). 28. Novyy Kanal, STB, and ICTV, were owned by Kuchma’s son-in-law, Victor Pinchuk, who also owned Ukraine’s largest daily newspaper, Fakty I Komentarii. Leading members of Medvedchuk’s propresidential SDPU controlled another two stations, Inter and Studio 1+1. “Negotiating the News: Informal Censorship of Ukrainian Television,” Human Rights Watch, 2003, as cited by D’Anieri 2005. 29. Hetman’s interview with Georgiy Zhebak, Shlax Peremogu, Kyiv, Ukraine, June 2006. 30. No relation to the coauthor to this chapter. 31. One high-ranking member of the Kyiv police force during the Kuchma Administration described the courts as the “he who gives more wins” system. “How else do you think judges that earn $500–700 a month are able to drive around in brand new Mercedes cars?” Hetman’s confidential interview with high-ranking police officer, Kyiv, Ukraine, June 2006. 32. A high-ranking member of the Kyiv police force during the Kuchma Administration asserts, “the police in Ukraine know only two commands: ‘Fas’ and ‘Foo’ [common commands that are taught to guard dogs, meaning ‘attack’ and ‘leave alone’].” Confidential interview with police officer, June 2006. This is confirmed by Yevhen Marchuk, former head of the Ukrainian Security Service (SBU): “If [your business] is loyal to the authorities, they will ignore or overlook anything. If you are disloyal, you or your business will be quashed immediately.” As cited by Way 2005: 4. 33. Gould’s interview with Nicole Davidson, British Embassy, Kyiv, Ukraine, July 16, 2003. 34. On his corporate website dating from 2003, Chervonenko wrote in the recognizable language of a market democrat: “I could be an oligarch and devote my-

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self to knocking out some benefits for me and my business but me and ‘Orlan’ team are for the honest business. We don’t need personal benefits. It always pays if you work honestly. Our business grew stronger. To make it possible for other companies working in Ukraine and for Ukraine it is necessary to create normal market and obligatory-for-everyone laws–‘rules of the game’ and make people keep within them. That is exactly why I started my political activity [sic].” See Yevhen Chervonenko, “Welcome to the Orlan-Trans Website,” http://www.orlantrans.com /english/pr-speach.html. During the 2004 campaign, he set up and operated Yushchenko’s private security team. Later, he was rewarded for his loyalty to the Ministry of Transportation. As of this writing, he is vice major of Kyiv. 35. Interview with Volodomyr Sidenko, July 17, 2003. 36. Yushchenko retained at least personal contacts with Kuchma’s richest supporters. For example, while the author was in Ukraine, Yushchenko attended a highprofile birthday party, taking a seat between Rinat Akhmetov and Viktor Pinchuk. Interview with Brian Medford, July 18, 2003. As neither oligarch was enamored with Yanukovych (Pinchuk was openly disdainful), these ties helped Yushchenko neutralize the oligarchs’ support when it mattered most. 37. Gould’s interview with Ihor Kohut, director, International Renaissance Foundation, Kyiv, Ukraine, July 15, 2003. See also Taras Kuzio, “Rifts Emerge Among Ukraine’s Elite,” RFI/RL Newsline, January 28, 2004, http://www.rferl.org /newsline/2004/01/5-not/not-280104.asp. 38. Yushchenko achieved a similar split in Ukraine’s security services. For more, see Binnendijk and Markovi´c 2006. 39. Medvedchuk and parliamentary speaker Volodymyr Lytvyn drew up the changes. Neither Yushchenko nor Tymoshenko was pleased. Tymoshenko’s supporters voted against it, while Tymoshenko, Yushchenko, and one-fifth of the Our Ukraine members abstained (Åslund 2009: 196). 40. Hetman’s interview with Leonid Finkelstein, editor-in-chief/co-owner, Fakt, Kyiv, Ukraine, June 2007. 41. Hetman’s interview with Valentin Zagaria, director, Legal Department, New Europe Private Equity, Kyiv, Ukraine, June 2006. 42. Interview with Yuriy Chuikov, June 2006. 43. Hetman’s interview with Oleksandr Popov (Our Ukraine), assistant to member of Parliament, Kyiv, Ukraine, June 2007. 44. Hetman’s interview with Olekciy Koshel, director, Rada, Kyiv, Ukraine, June 2007. 45. Hetman’s interview with Anatoly Yerema, producer, 1+1 TV, Kyiv, Ukraine, June 2007. 46. Greg Levine, “Steel Tycoon Warns Ukraine: Act ‘European’—Not Russian,” Forbes, June 2, 2005. 47. After growing by 13.8 percent in the first quarter of 2004, 15.7 percent in the second, 7.3 percent in the third, and 8.9 percent in the fourth quarter, foreign direct investment from Cyprus and the Virgin Islands grew by only 0.7 percent in the first quarter of 2005. FDI from Cyprus and the British Virgin Islands recovered by the third quarter of 2005, but remained only slightly more than half of what it had been in 2004 (Kuzmin 2005; Motyl 2005). 48. Interview with Igor Shpak, June 2006; interview with Volodymir Martenyuk, June 2006. 49. World Bank, World Development Indicators online, Washington, DC, 2007.

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In the official statistics, it appeared as if Ukraine’s trade surplus had been cut in half with a corresponding negative impact on GDP. One important thing that had changed, however, was the statistics’ accuracy (EBRD 2005: 205). 50. Those prosecuted came from all sectors of the government, including regional, district, and local levels. Charges included a Ministry of Defense official who attempted to solicit a $600,000 bribe from contractors; the president of the Ukrainian state reserve, who cost the state $7 million after illegally selling reserve fuel; and Ukraine’s chief prosecutor, who tried to seize 1,700 hectares of state property. “Ukraine,” United Kingdom Home Office Country of Origin Report online, June 2006, p. 8. http://www.homeoffice.gov.uk/rds/pdfs06/ukraine_060706.doc.

Chapter 8 1. External inducement is also possible. Vachudova demonstrates how the EU fostered political competition in Central Europe (Vachudova 2005; see also Grabbe 2006; Jacoby 2004). Unfortunately, conditionality strategies work best where there are both willing tutors and pupils (Jacoby 2001). 2. In a well-researched study of economic elite rivalry in Kazakhstan, Barbara Junisbai finds that financial industrial groups (FIGs) rather than clans often man the front lines of distributional conflict. These FIGs can trace clan outlines, but as often cross them (2010). The finding is an important warning against taking clandriven explanations of events too literally. Clan identities clearly matter, but crossclan business networks are also important units of collective identity and action. 3. Indeed, oil production has quadrupled since 2004, driving growth rates that frequently go to 20 percent. Petro-resources now account for 60 percent of GDP and 90 percent of export revenue (EBRD 2009: 141). 4. Eduard Shevardnadze was first secretary of the Georgian Communist Party from 1972 to 1985 and Soviet foreign minister from 1985 to 1990. 5. Note, for example, the “assassination” of the high-profile gangster/war criminal Arkan in January 2000.

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Accountability, 34, 35, 112, 122, 193(n15). See also Rule of law/“just state” institutions Akhmetov, Rinat, 146, 148, 150, 152 Akhvlediani, Anna, 176 Aleksandrov, Ihor, 156 Aliyev, Heidar, 170–173, 182 Appel, Hilary, 88 Asia, 137 Åslund, Anders, 141, 147–148 Asset stripping, 48, 49, 193(n17); Czech Republic, 89–91, 98; Georgia, 174; Serbia, 179; Slovakia, 127, 202–203(n48); Ukraine, 146 Association of Independent Slovak Economists (NEZES), 74, 76 Association of Slovak Workers (ZRS), 117, 131 Authoritarian regimes: and accountability, 193(n15); and Azerbaijan, 10, 169, 173; defined, 34–35; economic success of, 137; exclusively insider-dominated privatization frameworks, 47–48; illiberal politics reinforced by economics in states with statecontrolled oil rents, 166–167, 169–173; and Kuchma government

of Ukraine, 154–156; origins in inability to fully dislodge incumbent elites at moment of transition from communism, 44; and threats to democratic institutions in Slovakia, 122–125. See also Illiberal postcommunist states Azerbaijan, 9–10, 169–173, 181–182; characteristics of postcommunist state, 169–170; economic elite’s loyalty to regime, 9, 170–173, 181– 182; economy dominated by energy resource rents, 9, 169–171, 208(n3); election fraud, 173; kinship clans, 9–10, 171–173; move toward authoritarianism during regime crisis, 10, 169, 173; privatization programs, 169, 171, 185; state capture and corruption, 171–172, 184 AZZZ. See Federation of Employers Unions and Associations Balcerowicz, Leszek, 26, 32 Banka Slovakia, 201(n21) Banking sector: Azerbaijan, 172; Czech Republic, 84–89, 198(n10); debt loading, 87–88, 126;

229

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neoliberal economists’ prescriptions for, 24; Slovakia, 125–129, 131, 201(n21), 203(nn 53,54); Ukraine, 142, 147 Bankruptcy laws, 24, 87, 97, 126–127 Belzák, Jozef, 105–106 Bezsmertnyi, Roman, 158 Bisák, Peter, 117 Block of Yulia Tymoshenko, 156 Border guards (Ukraine), 154 Borovyk, Valerii, 160 Bruckmeyer, František, 201(n27) Bunce, Valerie, 36 Burjanadze, Nino, 176 Burjanadze-Democrats (Georgia), 176 Cagala, Milan, 117 ¸ Calfa, Marián, 60 Capek, Aleš, 198(n10) Capital markets: Czech Republic, 89– 95, 198(n14), 199(n20); Slovakia, 119–121, 130 ¸ Carnogurský, Ján, 71, 77–78, 105–107, 196(n48) CDU. See Christian Democratic Union Central Europe under Soviet control, 12, 18 ¸ ´ udovít, 75, 77–78, 106, 108 Cernák, L Chemapol, 93–95, 199(n20) Chervonenko, Yevhen, 157, 206(34) Chile, 33, 192(n8) Chornovil, Vyachislav, 156 Christian Democratic Movement (KDH; Slovakia), 62, 71–75, 77– 79, 105–106, 128, 196(n48) Christian Democratic Union (CDU; Czech Republic), 101 Chubais, Anatoly, 29, 42 Chuikov, Yuri, 161 ¸ c, Milan, 60 Ci¸ Citizens Union of Georgia (CUG), 174, 176 Civic Democratic Alliance (ODA; Czechoslovakia), 78, 101 Civic Democratic Party (ODS; Czech Republic), 63, 64, 82, 97, 99, 185 Civic Democratic Union (ODU; Czech Republic), 78–79

Civic Forum (OF; Czech Republic), 57, 63, 64, 78 Civic Movement (OH; Czech Republic), 63 Clan politics, 9–10; Azerbaijan, 170–173; Georgia, 174–175; Kazakhstan, 208(n2); and oligarchs’ aversion to further reforms in illiberal states, 168; use of “clan” terminology, 141, 204(n7) Clientism and patronage networks: Azerbaijan, 171–172; Czech Republic, 93, 101; fusion of oil and clan politics, 168; Georgia, 175– 176; and reasons for supporting the opposition during a regime crisis, 166; Serbia, 178–180; Slovakia, 110, 117, 130 Coal industry (Ukraine), 8, 144, 148– 150, 152 Coase, Ronald, 41 Coasian contracting, 41–43, 48–49, 53, 83 Collective farms, 12 Collins, Kathleen, 171 Command economy. See Economics under communist regimes Communism, 11–12. See also Economics under communist regimes Communist Party (Czechoslovakia), 38 Communist Party (USSR), 12 Competitive authoritarian regimes: defined, 34, 203–204(n2); economic component of competitive authoritarian dilemma, 136–137, 165–166; examples, 136; higher prevalence of partial reform scams in competitive authoritarian states than in liberal democratic states, 36; illiberal politics reinforced by economics in states with state-controlled oil rents, 166–173, 186–188; impact of oppositions, 135; instability of, 40, 47, 54, 134, 136, 166; limited scope of voucher privatization programs, 47, 171, 185; and neoliberalism, 137; origins in inability to fully

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dislodge incumbent elites at moment of transition from communism, 44, 139–140; and political competition theory, 137; political economy of, 136–139; possibility of economic actors defecting to the opposition, 51–53; short-term economic success, 204(n3); and threats to democratic institutions in Slovakia, 122–125. See also Azerbaijan; Georgia; Illiberal postcommunist states; Regime crises; Rent-seeking; Serbia; Ukraine Contracts, enforcement of, 24, 42–43, 48–49. See also Rule of law/“just state” institutions Corruption, scams, and self-dealing behavior, 35–36, 89–95, 101, 125– 130; beneficiaries of dysfunction in illiberal states, 186–187; equity market scams, 89–95; and expectations for privatization, 2, 42; higher prevalence of partial reform scams in competitive authoritarian states than in liberal democratic states, 36; and illiberal, insider privatization, 30, 128–129; import and export scams, 154; inflationbased scams, 142, 204(n8); self-dealing and lack of democratic constraints, 103, 117–118; and stealing from the workplace in command economies, 16; tax arrears, 36, 126–127. See also Asset stripping; Clientism and patronage networks; Partial reform phenomena; Rent-seeking; Tunneling; specific countries Croatia, 40, 47, 136 CS Fondy, 98 ¸ CSSD. See Czech Party of Social Democrats ´ ckovi´c, Nevenka, 30 Cu´ CUG. See Citizens Union of Georgia Czech Party of Social Democrats ¸ (CSSD), 97–99, 101 Czech Republic, 6, 81–101, 185; and clientism, 93, 101; compared to

231

Slovakia, 68–69, 72, 76, 126; conflict over partial reforms (dislodging the winners), 95–99; damage to economy from reforms, 89–101; debt issues, 86–89; and defense industry, 69; election of 1996, 97; election of 1998, 99; failure to depoliticize the economy, 82, 86, 88; insider trading, 198(n14); insiders’ bid for policy control, 92–93; as liberal democratic postcommunist state, 46, 82; macroeconomic stabilization prescriptions, 87; and neoliberal reform policies, 82–84, 96; policy mistakes and fixes, 82, 99–101; Prague Stock Exchange, 89; resignation of Klaus government (1997), 99; rise and fall of Czech equity markets, 89–95, 198(n14), 199(n20); Tošovský government, 99; weakness of left, 56, 82, 103. See also Klaus, Václav Czech Republic, privatization framework, 184; Chemapol case (privatization of oil refineries), 93– 95, 199(n20); Czech way of ¸ privatization (Ceská cesta), 92–95, 199(n25); and damage done to minority first shareholders, 91–92, 101; enterprise efficiency not enhanced by dominant shareholders, 90–91; and financial intermediaries, 84–89; impact of privatization on democratization, 100–101, 185; IPFs (investment privatization funds), 85–87, 198(n12); and minority shareholder protection, 89–92, 95–96; National Property Funds (FNMs), 85, 198(nn 10,13), 199(n20); reforms eventually benefitting insiders, 82; reforms initially benefitting outsiders, 82, 101; reforms instituted without adequate institutional checks, 82–83, 87–95, 101; second wave of privatization, 56, 81–84; struggles over enterprise control, 83–84, 96; summary of

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consequences of privatization process, 99–101; tunneling and asset stripping, 89–91, 98, 198(n13); unethical profiteering eventually limited due to competitive political process, 95– 101, 104; voucher privatization system, 82–84, 185, 199(n20); voucher system and state banks, investment funds, and soft budgets, 84–89, 198(n10) Czechoslovakia, 6, 55–79; breakup and fall of VPN, 76–79; civil society, 19; Communist Party’s lack of portable skills after 1989, 38; currency convertibility, 22; debate over name of postcommunist state, 71; decentralization experiment, 17–18; devolution of economic power to republic-level governments, 74; differences between Czech and Slovak economies, 72; elections of June 1992, 79; end of hyperrationalist experiment, 19–20; founding elections of June 1990, 62; Government of National Understanding, 58, 59; hard-liners’ fiscal policies, 19; impact of reforms greater in Slovakia than in Czech lands, 76; and inflation, 58, 59; Klaus’s neoliberal reform package, 59–63, 66; Klaus’s rise to power, 59; leaders of postcommunist government, 59–60; as liberal democratic postcommunist state, 46, 56; lustration (political cleansing) programs, 57, 63, 106, 195(n19); and macroeconomic stabilization, 22, 73; mutual distrust between old and new left, 58; new left (’68ers and other dissidents), 57–58; Prague Spring (1968), 17; restrictions on wage increases, 58; separation of Czech and Slovak Republics (1993), 46, 133; Slovak separatist movements, 71–72; Velvet Revolution (1989), 46, 56–

59, 63, 133; Warsaw Pact invasion of 1968, 17, 57; weakness of postcommunist left, 56–58. See also Czech Republic; Slovakia Czechoslovakia, privatization framework, 55–79, 184, 195(n20); commercialization of state enterprises, 65; Czech Plan, 60–61; and defense industry, 69–70; emphasis on rapid privatization prior to establishment of supporting legal framework, 66–67; establishment of Czech and Slovak privatization framework, 56–68; and gradualism, 59–60, 62, 66, 70, 75; Large Scale Privatization Act (1991), 68; leaders of postcommunist government, 59–60; and low levels of citizen savings, 64; National Property Funds (FNMs), 61, 65; and neoliberalism, 59–63, 66, 70, 76, 78; 97+3 plan, 66; outsiderdesigned reforms, 56, 58–68; political objectives, 64; radical reform and return of the “old left” in Slovakia, 68–79; Slovakia impacted more than Czech lands, 76; tripartite negotiating forum, 58, 194(n4); voucher privatization system, 60–61, 64–65, 67. See also Czech Republic; Klaus, Václav; Slovakia; T¸ríska, Dušan D’Anieri, Paul, 141 Debt: Czech Republic, 86–89; debt loading, 87–88, 126; Hungary, 19; Poland, 18–19; Slovakia, 126–127, 130, 203(nn 49,50); Ukraine, 147 Deegan-Krause, Kevin, 112 Defense industry (Slovakia), 69–70, 75 Democracy: degree of liberalization as predeterminant of direction and pace of economic reform, 3; “delegative democracy,” 33; effects of privatization on liberalization dependent on economic and political conditions, 5; and external pressure, 39–40, 124–125, 134,

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208(n1); gradualists replaced by political liberals as opponents of neoliberalism, 27; less pressure to democratize in resource-rich states, 9, 166–173, 181; neoliberals’ predisposition to circumvent democracy, 29, 32–33, 38; political competition theorists’ defense of, 29. See also Competitive authoritarian regimes; Liberal democratic regimes Democracy and the Market (Przeworski), 31 Democratic Party (DS; Slovakia), 128 Democratic Union (DU; Slovakia), 113–114, 128 Denisova, Irena, 51 Desai, Raj, 85, 198(n10) Djindji´c, Zoran, 180 Dlouhý, Vladimír, 59, 92–94, 194(n5), 195(n23) DMD Holdings, 127–128 ´ ubomír, 107–108, 114, Dolgoš, L 200(n8) DS. See Democratic Party DU. See Democratic Union Ducký, Ján, 55, 110, 117, 129–130 Duik, Nadia, 150 Easterly, William, 103 Eastern Slovak Steelworkers. See Východoslovenské železiarne Economic agents. See Clan politics; Corruption, scams, and self-dealing behavior; Insider privatization in illiberal regimes; Insider privatization in liberal democratic regimes; Managers; Minority shareholders; Outsider privatization in liberal democratic regimes; Owners; Regime crises; Workers; specific countries Economics in the early postcommunist era, 19–27; and Balcerowicz’s “extraordinary politics,” 32; and blueprints for economic reform, 19–27; gradualist prescriptions for economic transformation, 21, 26; hardships for workers, 31;

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macroeconomic stabilization, 22– 23; neoliberal prescriptions for economic transformation, 21–25; summary of conditions and challenges, 20–21. See also Political economy of postcommunist economic reform Economics under communist regimes, 11–27; Czechoslovak Prague Spring experiment (1968), 17; difficulty of making transition from growth based on resource mobilization to growth based on better use of existing resources (intensive growth), 17–18; entrenched partyadministrative class, 13; failures of collectivization, 12; high growths driven by coercive mobilization of resources, 13–14; initial high growth rates in industrial and defense sectors followed by reversal of growth rates, 12–13; misalignment between microincentives of the average person and macroneeds of the state, 13; nail factory example as illustration of difficulties, 14–16; propaganda and repression, 13–14; state planning and the hyperrationalist principle, 11–19; unintended consequences of command economies, 15–16; unsuccessful Hungarian experiment in decentralization, 16–18 Egan, Michelle, 86 Ekiert, Grzegorz, 36 European Bank for Reconstruction and Development, 137 European Union (EU), 39, 124–125, 134, 208(n1) Expandia Funds, 199(n20) Federal Republic of Yugoslavia, 45 Federation of Employers Unions and Associations (AZZZ; Slovakia), 105–107, 116–117, 127 Ferrimex, 118

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Filkus, Rudolf, 70, 72, 76, 77, 196(n35) Financial sector. See Banking sector; Capital markets Finkelstein, Leonid, 160 Fish, M. Steven, 36–37 Fisher, Sharon, 117 FNM. See Fund for National Property Fokin, Vitold, 204(n6) For a United Ukraine, 155 Foreign investment: Azerbaijan, 170; Czech Republic, 91; Slovakia, 119; Ukraine, 151, 153, 162, 205(n15), 207(n47) Freedom Union (Czech Republic), 99 Friedman, Milton, 25, 33 Fukuyama, Francis, 11 Fund for National Property (FNM; Slovakia), 108–109, 112, 115–116, 127, 201(nn 21,29) Gagnon, V. P., 180 Gál, Fedor, 75, 77–78 Gamsakhurdia, Zvaid, 173 Ganev, Venelin, 44–45 Gaulider, František, 123 Gavorník, Štefan, 109, 117, 118 Georgia, 9, 173–178; characteristics of postcommunist state, 169–170; corruption and organized crime, 174–175, 177, 184; economy based on manufacturing and services, 169; elections of 2003, 40, 136; illiberal leadership in early postcommunist era, 10; kinship clans and patronage networks, 9–10, 174–176; lack of elite solidarity during regime crisis, 176–178; lack of oil resources, 174, 175, 177; macroeconomic stabilization, 175, 178; media, 176–178; move toward liberal democracy during regime crisis, 169; privatization programs, 174– 175, 185; relation of economic elites to regime, 173–176; war with Russia (2008), 178 Global financial crisis of 2008, 162 Gongadze, Heorhiy, 150, 156, 206(n25)

Gorbachev, Mikhail, 19 Gradualism: and Czechoslovakia, 59–60, 62, 66, 70, 75; goals and strategies for transforming postcommunist economies, 21, 26; gradualists’ critique of neoliberalism, 25–27; and Hungary, 26; risk of gradual reforms, 31–32; and Slovakia, 114 Grey, John, 38 Grzymala-Busse, Anna, 38, 40 Guliyev, Farid, 171–172 Hall, John, 192(n2) Harvard Capital and Consulting, 84–85 Harvard Investment Company, 121 Hatina, Slavomír, 118 Havel, Václav, 57–63, 69–70 Havrylyshyn, Oleh, 141 Hayduk, Vitaly, 152 Hayek, Friedrick, 62, 83, 106 Hellman, Joel, 35, 36, 37, 139, 186 Hetman, Vadym, 156 Hetman, Yaroslav, 133 Hoff, Karla, 49, 81 Hol¸cík, Ján, 105 Hromada, 143 Huba, Mikuláš, 196(n36) Hume, David, 48 Hungary, 16–20, 26 Húska, Marián, 74, 77, 196(n34) Hutník, 118 Hyperrationalism, 11–19, 29 HZDS. See Movement for a Democratic Slovakia Identity politics, 47, 56, 71–76, 79, 104, 168 IDS. See Industrial Union of Donbas Illiberal postcommunist states, 139– 147; default expectations for actors in illiberal states, 52–53; fusion of oil and clan politics, 168; illiberal politics reinforced by economics in states with state-controlled oil rents, 166–167, 186–188; oligarchs’ aversion to further reforms in illiberal states, 4, 35–36, 49, 53, 104, 122–125, 127, 132, 146, 151,

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165–173; origins in inability to fully dislodge incumbent elites, 44, 139–140; relationship between power and privatization, 185–186. See also Azerbaijan; Georgia; Insider privatization in illiberal regimes; Regime crises; Serbia IMF. See International Monetary Fund Imitation democracies. See Competitive authoritarian regimes Industrial Union of Donbas (IDS), 148, 150 Industry Will Save Georgia (IWSG), 177 Insider privatization in illiberal regimes, 43–49, 55; and actions of economic agents in times of crisis, 134; and battles over privatization frameworks, 47; conditions leading to support for political and economic liberalization, 30; and factors shaping privatization framework, 43–49; and oligarchs’ aversion to further reforms, 4, 35–36, 49, 53, 104, 122–125, 127, 132, 165–173, 185–186; politicization of bank privatization in Slovakia, 128–129; and promotion of monopolies and corruption, 30. See also Authoritarian regimes; Azerbaijan; Competitive authoritarian regimes; Croatia; Regime crises; Russia; Serbia; Ukraine Insider privatization in liberal democratic regimes, 43–47, 55; nationalism/identity politics as justification for, 47, 73–76, 79; and threats to democratic institutions, 46–47, 104–105. See also Poland; Slovakia; Slovenia Insiders, examples of, 44 International Monetary Fund (IMF), 21, 40 International Oil Companies (IOC), 93, 95 Interpipe, 149 Investment and Development Bank (IRB; Slovakia), 128–129, 131

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Investment privatization funds (IPFs), 85–87, 113, 198(n12) IOC. See International Oil Companies IPFs. See Investment privatization funds IRB. See Investment and Development Bank IWSG. See Industry Will Save Georgia Jani¸cina, Milan, 113 Jaruzelski, Wojciech, 19 Ježek, Tomáš, 59, 61, 66, 96 Junisbai, Barbara, 51, 208(n2) “Just state” institutions. See Rule of law/“just state” institutions Kari´c, Bogoljub, 180 Kaufmann, Daniel, 139 Kazakhstan, 208(n2) KDH. See Christian Democratic Movement Keynes, John Maynard, 25–26 Kinakh, Anatoliy, 158, 163 Klaus, Václav, 6, 185; background of, 59, 194(n5); and Chemapol case (privatization of oil refineries), 94; and clientism, 93, 101; and Czech way of privatization, 94–95; and damage done to minority first shareholders, 92, 101; design of privatization framework, 63–68, 195(n20); and Dlouhý, 195(n23); and election of 1996, 97; emphasis on rapid privatization prior to establishment of supporting legal framework, 66–67, 83, 87; and enterprise managers, 67, 92; and financial intermediaries, 84–89; and Havel, 59–60, 63; loss of popular support, 97–98; and lustration policy, 63; neoliberal reform policies, 59–68, 96; objections to national property fund, 61; and ODS, 63, 64; and partial reform winners and losers, 96; personality, 194(n13); polarization of reform discourse, 61–63; political objectives of reform policies, 64; popular appeal of, 61–62; relation

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with ex-communists, 195(n18); reluctance to increase market regulation, 96–97; resignation following ODS financing scandal (1997), 99; and restitution of property, 66, 195(n24); rise to power, 59; and Rudlov¸cák, 98; and rule of law, 101; unwillingness to regulate capital market, 89 K¸nažko, Milan, 77 Ko¸cárník, Ivan, 87, 98 Komárek, Valtr, 59, 60, 61, 194(n5) Kornai, János, 16 Koshel, Olekeiy, 161 Kouba, Karel, 61, 194(nn 5,13) Ková¸c, Michal, 2, 108–110, 122, 200(n12) Ková¸c, Michal, Jr., 2, 123–124 Kožený, Viktor, 85 Kravchuk, Leonid, 140 Kryvorizhstal steel mill, 152, 162 Ku´can, Milan, 45 Ku¸cerák, Jozef, 70–71, 76, 78 Kuchma, Leonid, 7, 204(n6); commitment to economic reforms as prime minister, 140; competitive authoritarian regime, 154–156; consolidation of presidential power after 1999 elections, 150–153; election fraud, 154; extreme politization of the economy, 150– 152; halt to rapid liberal reform and dismissal of Yushchenko and Tymoshenko, 150; origins in industrialized region of Ukraine, 135; patronage network, 151; presidency won in 1994 elections, 140–141; presidential powers strengthened under new constitution (1996), 141; and regime crisis of 2004, 135–136, 155–162; and subservient broadcast media, 156; survival strategy and balance of power among competing oligarchic groups, 143 Kyrgyzstan, 136 Labor, hoarding of, 15 Labor unions, 56–58, 68

Lazarenko, Pavol, 143, 146 Left, portable skills of: Czechoslovakia, 56–58; and factors shaping privatization framework, 43; Poland, 45; and privatization frameworks in liberal democratic regimes, 45; Slovakia, 56; Slovenia, 45 Legal codes. See Rule of law/“just state” institutions Levitsky, Steven, 34, 40, 134, 167, 203(n2) Lexa, Ivan, 109–110, 122–123 Liberal democratic regimes: and accountability, 193(n15); defined, 33–34; development of “just state” institutions, 48–49; and factors shaping privatization framework, 43–49; higher prevalence of partial reform scams in competitive authoritarian states than in liberal democratic states, 36; origins in existence of active opposition and fair founding elections, 44–45; privatization framework depending on portable skills of the left, 45; privatizations’ potential to reinforce liberalism, 53; reciprocal relationship between competitive markets and liberal democracy, 187; relative success of privatization in, 4; self-transformative capacity of, 192(n6); weakly liberal states, 46– 47. See also Czech Republic; Czechoslovakia; Poland; Rule of law/“just state” institutions; Slovakia; Slovenia Lustration programs, 57, 63, 106, 195(n19) Macroeconomic stabilization, 20, 22– 23; Czech Republic, 87; Czechoslovakia, 60–61, 73; Georgia, 175, 178; Hungary, 26; Poland, 26–27; Ukraine, 142–143, 147 Magula, Jozef, 121, 202(n41) Manager (private company), 111–112 Managers: Czech Republic, 67, 87, 90, 92; Czechoslovakia, 56, 58, 66–69,

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76, 78; Slovakia, 107, 108, 114– 120, 200(n3); Ukraine, 145, 146 Mandelbaum, Michael, 21 Markovi´c, Ante, 179 Markuš, Jozef, 69–70, 71, 194(n5), 196(n36) Martenyuk, Volodymyr, 154 Martynenko, Mykola, 157 Mass-action privatization programs (voucher programs): Azerbaijan, 171; Czech Republic, 82–89, 99– 101; Czechoslovakia, 60–61, 64–65, 67–68; limited scope of voucher privatization programs in competitive authoritarian regimes, 47, 171, 185; and neoliberal expectations for second owners, 193(n18); and relationship between power and privatization, 185; Slovakia, 104, 105–108, 113, 115, 200(n8); Ukraine, 145, 185 Me¸ciar, Vladimír, 2, 6–7, 186, 201(n29), 202(n34); and abuse of state property, 129; alliance with enterprise managers and former apparatchiks, 56, 76, 78, 114; Berghauer, Zoltán, 111; and breakup of VPN, 76–79; and clientism, 110, 117, 130; conflicts with presidency, 108–109, 122– 123; consolidation of power, 109–110; control of Slovak Information Services (SIS), 122– 123; direct sales program, 104, 108, 110, 116–118; and election of June 1992, 79; electoral defeat of October 1998, 131–132, 134; goals of second round of privatization, 104, 110, 114; and HZDS, 78–79, 107–111; and identity politics, 71–73; and lack of transparency, 110; and nationalism in privatization, 118–119; and neoliberalism, 114–115; noconfidence vote of March 1993, 110, 112; politicization of bank privatization, 128–129; privatization under third government (1994–1998), 113–121;

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and privatization’s partial reforms, 125–130; second government (1992–1994), 107–112; suspicions toward foreign joint ventures, 119; temporary loss of power, 104, 112– 113; and threats to democratic institutions, 122–125; voucher privatization cancelled, 104, 115; and VSŽ and the Slovak way of privatization, 111–112 Media, 185; Azerbaijan, 172; Georgia, 176–178; Serbia, 180; Slovakia, 123–124, 202(n46); Ukraine, 156 Medvedchuk, Viktor, 146, 150, 152, 156, 207(n39) Melnychenko, Mykola, 155, 206(n25) Mertlik, Pavel, 198(n10) Mikloš, Ivan, 76, 78, 105–106, 130, 199(n2), 200(n3), 201(n29) Miller, Petr, 62 Miloševi´c, Slobodan, 178–180 Minority shareholders, 103–104, 120– 121, 146–147, 185 Ml¸coch, Lubomír, 83, 194(n5) Morav¸cik, Jozef, 110, 112 Moríc, Vit’ázoslav, 103 Morozov, Oleksander, 157 Motoinvest, 98 Movement for a Democratic Slovakia (HZDS), 77–79, 202(n34); and debt, 127; and election of 1998, 131; and Me¸ciar’s second government, 107–111; and Me¸ciar’s third government, 114; and pressure on media and civic society, 123; split from VPN, 105; and VSŽ, 111 Müller, Jan, 98 Muskhelisvili, Marina, 176 Mykhnenko, Vlad, 138, 149–150, 159 Nafta Gbely, 117–118 Nail factory, as example of problems in command economy, 14–16 National Bank of Slovakia (NBS), 125, 129–131, 201(n21), 203(n54) National Bank of Ukraine (NBU), 142, 147 National Property Funds (FNMs;

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Czechoslovakia), 61, 65, 85, 198(nn 10,13), 199(n20) Nationalism, 47, 71–76, 104, 118–119, 134 NATO. See North Atlantic Treaty Organization NBS. See National Bank of Slovakia NBU. See National Bank of Ukraine Neoliberalism, 31–53, 96, 134, 180, 192(n8); banking prescriptions, 24; catastrophic short-term consequences, 25–26, 192(n8); Coasian contracting, 41–43, 48–49, 53, 83; and consequences of rapid privatization in states lacking rule of law, 49; and creation of second owners through mass privatization programs, 193(n18); and creative destruction of the market, 25–26; critique of assumption that economic reform drives political reform, 33, 49; critique of assumption that neoliberal market economy is preferable to other varieties of capitalism, 137; and Czech Republic’s privatization framework, 82–84, 96; and Czechoslovakia’s privatization framework, 59–63, 66, 70, 76, 78; debate with political competition theorists, 29, 31–41, 43; democracy’s long-term incompatibility with neoliberal blueprint for transformation, 29, 38; emphasis on rapid privatization prior to establishment of supporting legal framework, 66–67, 83, 87, 96–97, 192(nn 4,6); expectation that economic reform would drive political reform, 33, 48, 50, 53, 180–181; expectations for illiberal states, 48, 134, 180–181; expectations for postprivatization agents’ political behavior, 33, 50, 53; goals and strategies for transforming postcommunist economies, 21–25; gradualists’ critique of, 25–27; hyperrationalist blueprint for transformation, 29;

implicit assumption of need to isolate economic policymakers from democratic forces, 32–33; and lack of protection for minority shareholder rights, 103–104; macroeconomic stabilization prescriptions, 22–23; narrow scope of applicability, 43; and need for market institutions to enforce contracting, protect property rights, etc., 42, 49–50; neoliberal political economy, 31– 33; Poland as example, 26–27; privatization prescriptions, 24, 41–49; and problem of states lacking institutions of a “just state,” 42–43, 48–50, 103–104; and risk of gradual reforms, 31–32; and Russia, 48; and Slovakia, 70, 115; structural change prescriptions, 23–24; and Ukraine’s Orange Revolution, 50–51, 138; and workers, 31 New Azerbaijan Party (YAP), 172–173 New Rights Party (NRP; Georgia), 177, 178 NEZES. See Association of Independent Slovak Economists North Atlantic Treaty Organization (NATO), 124–125 NRP. See New Rights Party Oberhauser, Viliam, 74–75, 105–106, 196(n48) O’Donnell, Guillermo, 33 ODS. See Civic Democratic Party ODU. See Civic Democratic Union OF. See Civic Forum OH. See Civic Movement Oil industry: Azerbaijan, 9, 169–173, 208(n3); fusion of oil and clan politics, 168, 170–173; and increased growth rates in Central Europe during the 1970s, 18; and lack of opposition unity, 167; less pressure to democratize in resource-rich states, 9, 166–173, 181; privatization of oil refineries (Czech Republic), 93–95; and

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scams in Ukraine, 143. See also Rent-seeking Olsson, Michael, 120 Orange Revolution (2004; Ukraine), 8–9, 50–51, 138, 156–162; aftermath, 162–163 Orenstein, Mitchell, 37–38, 62, 192(n9) Our Ukraine, 155, 156, 157 Outsider privatization in liberal democratic regimes, 43–46, 101. See also Czech Republic; Czechoslovakia Outsiders, examples of, 44 Owners: and challenges of early postcommunist period, 31; conditions under which postprivatization entrepreneurs defect to the opposition, 51–53; creation of second owners through mass privatization programs, 193(n18); different attitudes toward liberalization in resource-poor vs. resource-rich societies, 9, 166–173, 181; enterprise efficiency not enhanced by dominant shareholders in Czech Republic, 90–91; and insider-controlled capital market regulation in Slovakia, 120; lack of elite solidarity during regime crisis (Georgia), 176–178; lobbying for monopolies, 4; and need for policing the intersection of business and politics, 10; oligarchs’ aversion to further reforms in illiberal states, 4, 35–36, 49, 53, 104, 122–125, 127, 132, 146, 151, 165–167, 185–186; and reinforcement of authoritarianism in states with state-controlled oil wealth, 166–167. See also Asset stripping; Corruption, scams, and self-dealing behavior; Minority shareholders; Postprivatization agency, theory of; Rule of law/“just state” institutions; Tunneling Palouš, Martin, 63 Partial reform phenomena, 35–36, 104;

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Czech Republic, 89–99, 101; higher prevalence of partial reform scams in competitive authoritarian states than in liberal democratic states, 36; partial reform constituents’ resistance to additional reform, 35– 36, 127; politicization of bank privatization, 128–129; self-dealing and lack of democratic constraints, 103, 117–118; Slovakia, 111–121, 125–130; Ukraine, 53, 141–143, 154. See also Corruption, scams, and self-dealing behavior Party of Civic Understanding (SOP; Slovakia), 131 Party of Industrialists and Entrepreneurs (PIE; Ukraine), 158, 163 Party of the Democratic Left (SDL’; Slovakia), 72, 78, 112–114, 132 Patakartsishvili, Badri, 178 Patronage. See Clientism and patronage networks PIE. See Party of Industrialists and Entrepreneurs Pinchuk, Viktor, 146, 149, 150, 158 Pinochet, Gustav, 33, 192(n8) Pithart, Petr, 60, 61 Poland: borrowing from Western banks (1970s), 18; civil society, 19; debt problem, 18–19; early postcommunist era, 20; end of hyperrationalist experiment, 19–20; as example of neoliberal reform, 26–27; failure to restructure stateowned enterprises, 27; insider privatization framework, 45; as liberal democratic postcommunist state, 45; and portable skills of the left, 45; recognition of Solidarity movement, 19 Political competition theory: benefits of frequent government turnovers, 38; and Czech Communist Party’s lack of portable skills after 1968, 38; debate with neoliberalism, 29, 31–41, 43, 137; and democracy’s long-term incompatibility with neoliberal “utopian project,” 38;

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domestic vs. external pressure for political liberalization, 39–40; and economic success of authoritarian regimes, 137; illiberal political and economic reform pattern in incumbent-led postcommunist states, 37; and instability of competitive authoritarian regimes, 40, 51, 134; and limits on social damages from reforms, 38; and partial reform scams, 35–37; and policy mistakes, 37–38; and policy moderation, 38; and portable skills of the postcommunist left, 43–48; and postprivatization agents’ political behavior, 50–53; privatization’s impact on political transformation depending on regime type, 43–51; and regime types, 33–49; and robust competition for power as precursor to economic success, 137; and short-term economic booms in competitive authoritarian regimes, 204(n3); and Ukraine, 134–136, 138 Political economy of postcommunist economic reform, 29–54, 136–139; beneficiaries of dysfunction in illiberal states, 186–187; illiberal political and economic reform pattern in incumbent-led postcommunist states, 37; need for credible opposition, 37; neoliberal model of privatization, 41–49; neoliberal political economy, 31– 33; partial reform constituents’ resistance to additional reform, 35–36, 127; and partial reform equilibrium, 35–36; and regime types, 33–35, 43–54; theory of postprivatization agents’ political behavior, 50–53. See also Neoliberalism; Political competition theory; specific countries Polyani, Karl, 38 Poor, Vladimír, 118, 202(n34) Poroshenko, Petro, 157, 163

Postprivatization agency, theory of, 50–53. See also Clientism and patronage networks; Insider privatization in illiberal regimes; Insider privatization in liberal democratic regimes; Outsider privatization in liberal democratic regimes; Regime crises Prague Spring (1968), 17 Prague Stock Exchange, 89 Privat Group/Privatbank, 148, 150 Privatization, expectations for, 1–2; expectations for improved economic efficiency, 1–2, 183; expectations for political change, 2, 183; expectations not realized in much of postcommunist Europe, 4, 48–49, 53, 183; neoliberal expectations, 24, 32–33, 48, 50, 53, 183; power as goal of privatization for many postcommunist governments, 185–186 Privatization programs: and actions of economic agents in times of crisis, 134; Azerbaijan, 169, 171, 185; and banking sector, 24; and complications in illiberal states, 181; factors shaping privatization framework, 43–49; Georgia, 169, 174–175, 185; impact of institutional context, 30; importance of political context, 184; insider privatization in illiberal regimes, 30, 43–49; insider privatization in liberal democratic regimes, 43–49; and insiders’ control of transformation from communism, 30; and the left’s portable skills, 43; limited scope of voucher privatization programs in competitive authoritarian regimes, 47; neoliberal assumptions about property rights and enforcement of contracts, 42; neoliberal prescriptions and expectations, 24, 32–33, 183; and oppositions’ control of transformation from communism, 30; outsider privatization in liberal democratic

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regimes, 43–49; privatization as high-stakes competition among rival claimants to state-owned property, 30; privatization framework term explained, 43; and problems with partial reform, 35– 36; recommendations for, 187–188; relationship between power and privatization, 185–186; Russia, 192(n11); Serbia, 169, 179–180, 185; short term vs. long term consequences, 5; summary of conclusions, 183–188. See also Czech Republic, privatization framework; Czechoslovakia, privatization framework; Slovakia, privatization framework; Ukraine, privatization framework Prognostics Institute, 60, 194(n5) Property rights: Czech Republic, 82–83; and expectations for privatization, 2; and impact of creating agents before institutions, 49, 126; lack of protection for minority shareholder rights, 103– 104, 120–121, 146–147, 185; need for, 24, 42–43, 48; not necessary in states with state-controlled oil wealth, 167; Slovakia, 126; Ukraine, 146–147 Prvá slovenská investi¸cná skupina (PSIS), 121 Przeworski, Adam, 31, 33, 34, 192(n3) PSIS. See Prvá slovenská investi¸cná skupina Public Against Violence (VPN; Slovakia), 57, 71–73, 75; breakup and fall, 76–79; campaign slogan, 62; dismissal of the old left, 68; HZDS split from, 105; Platform for a Democratic Slovakia, 77 Public-choice methodology, 192(n6) Pynzenyk, Viktor, 140 Rasizade, Alec, 172 Regime crises, 54; and allegiance switching, 51–53, 138–139, 155– 156, 158, 166, 178, 180, 181;

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Azerbaijan, 169–170, 172–173; and battles over privatization frameworks, 47; and differences among economic elites, 139; examples, 40, 136; Georgia, 169– 170, 176–178; and lowering of opportunity costs of disloyalty to the regime, 30, 51–53, 164, 166; and outcomes in states with statecontrolled oil wealth, 166–173, 181; Serbia, 169–170, 179–180; Slovakia, 131–132, 134; and strategic calculations of economic agents, 166, 181; Ukraine, 135– 136, 138, 166 Regime types: “delegative democracy,” 33; origins of, 44–45; types described, 33–35. See also Authoritarian regimes; Competitive authoritarian regimes; Liberal democratic regimes Rehák, Milan, 117 Remíaš, Róbert, 2–3, 123 Rent-seeking, 135, 141, 144, 148, 155, 186–188, 192(n6). See also Oil industry Režes, Alexander, 111–112, 118, 131, 202(n34) Rudlov¸cák, Vladimír, 66, 68, 83, 85, 90, 91–92, 98 Rule of law/“just state” institutions, 48– 49, 182; bankruptcy laws, 24, 87, 97, 126–127; enforcement of contracts, 24, 42–43, 48; and fusion of oil and clan politics (Azerbaijan), 172; illiberal politics reinforced by economics in states with statecontrolled oil rents, 166–173, 181–182; impact of creating agents before institutions, 48, 49, 82–83, 87–95, 101, 146–147, 185; impact of institutional context on privatization programs, 30; impact of privatization in the absence of the rule of law, 49, 83, 101, 185; lack of legal codes protecting property rights, enforcing contracts, etc., in early postcommunist era, 21, 48–49, 146–147; need for market

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institutions of a “just state,” 48–50; neoliberal emphasis on rapid privatization prior to establishment of supporting legal framework, 66–67, 83, 87, 96–97, 192(nn 4,6); neoliberal hopes that lawlessness will engender demand for market institutions, 104, 180–181; oligarchs’ aversion to further reforms in illiberal states, 4, 35–36, 49, 53, 104, 122–125, 127, 132, 146, 151, 165–173, 185–186; and Yushchenko candidacy (Ukraine), 158. See also Corruption, scams, and self-dealing behavior; Property rights Ruml, Jan, 63, 78, 92–93, 94 Rushchyshyn, Vyacheslav, 154 Russia: financial crisis of 1998, 147– 148; limited scope of voucher privatization programs in competitive authoritarian regimes, 47; and neoliberalism, 48; privatization programs, 192(n11); war with Georgia (2008), 178 Saakashvili, Mikhail, 176 Sachs, Jeffrey, 21, 25, 32 Schuster, Rudolf, 131 Schütte, Clemens, 86, 198(n10) Schwartz, Andrew, 43, 87, 89, 91, 193(n16) Scott, James, 192(n8) SDL’. See Party of the Democratic Left Serbia, 9, 136, 178–180; characteristics of postcommunist state, 169–170; corruption and organized crime, 179–180; economy based on manufacturing and services, 169; elections of 2000, 40; illiberal leadership in early postcommunist era, 10; lack of elite solidarity during regime crisis, 179–180; media, 180; move toward liberal democracy during regime crisis, 169; patronage networks, 178–180; postprivatization scams, 184; privatization programs, 169, 179–

180, 185; relation of economic elites to regime, 178–180 Shevardnadze, Eduard, 173–177 Shortages, 15–16 Sickner, Carl, 51, 165 Sidenko, Volodymyr, 157 Šik, Ota, 17, 60 Slovak Christian Democratic Movement (SKDH), 78, 196(n48) Slovak Christian Democratic Union (SKDU), 132 Slovak Gas Industry (SPP), 129–130 Slovak Information Services (SIS), 2– 3, 122–124 Slovak National Party (SNS), 72, 78, 79, 114, 118 Slovakia, 6–7, 103–132; abuse of state property, 129; assassination of Remiáš, 123; breakup and fall of VPN, 76–79; caretaker government of March–November 1993, 112– 113; compared to Czech Republic, 68–69, 72, 76, 126; constitution, 122; Constitutional Court, 115–116, 122, 123; debt issues, 126–127, 130, 203(nn 49,50); defense industry, 69–70, 75; democratic institutions nearly overturned, 46– 47, 54, 104–105, 122–125; and devolution of economic power, 74; economic damage from Me¸ciar’s policies, 105, 119; economic damage from partial reforms, 125– 130; elections of 1998, 40, 131–132; and EU leverage, 39; and foreign investors, 119; government pressure on media and civil society, 122–124; and gradualism, 70; identity politics, 71–76, 79; as in-between case study, 104; insider-controlled capital market regulation, 119–120; international censure for assaults on democratic institutions, 124–125, 134; KDH reform alternative, 74–75; kidnapping of Michal Ková¸c Jr., 122–124; lack of transparency in capital market, 121; as liberal democratic postcommunist state,

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46; macroeconomic stabilization, 125, 130; Me¸ciar-era self-dealing eventually limited by competitive politics, 105, 131–132; Me¸ciar’s second government (1992–1994), 107–112; Me¸ciar’s temporary loss of power (1994), 104; media, 124, 202(n46); as model for illiberal case studies, 134; mutual funds, 121; and neoliberal reform policies, 70; political center’s beliefs about reforms, 76; political influence regained by ex-communist left due to alliance with nationalists, 46, 56, 68–79; radical reform and return of the “old left” (insiders regain influence), 68–79, 104; regime crisis of 1998, 131–132, 134; Revitalization Act, 127–128; separatist movements, 71–72; SIS kidnapping of Michal Ková¸c Jr., 2; Slovak Information Services (SIS), 122–124; slowing macroeconomic performance, 130; steel industry, 75; tax arrears, 126–127; and threats to democratic institutions, 104–105, 122–125; tunneling and asset stripping, 127, 202–203(n48); weakness of presidency, 122, 200(n12). See also Ková¸c, Michal; Me¸ciar, Vladimír Slovakia, privatization framework, 184; cancellation of second-wave voucher system privatization, 56, 107; direct sales program, 104, 108, 112–113, 116–118, 200(n3); elimination of privatization-related scams, 54; Fund for National Property (FNM), 108–109, 112, 115–116, 127, 201(nn 21,29); illegal sale of Nafta gbely, 117– 118; industries exempted from privatization by Strategic Enterprises Act, 116; insiders as beneficiaries, 108, 114–120, 128– 129; Large Scale Privatization Act (1991), 110; Ministry of Privatization, 108–109, 113; and minority shareholder protection,

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120–121; nationalist-populist privatization, 114–116, 118–119; off-market trades, 121; planned second wave of voucher privatization, 113, 200(n8); political goals of reoriented privatization program, 104; politicization of bank privatization, 128–129; privatization under Me¸ciar’s second government (1992–1994), 107–112, 200(n8); privatization under Me¸ciar’s third government (1994– 1998), 113–121; regionally based privatization groups, 117, 202(n34); second wave of voucher privatization cancelled, 104; s hift in privatization framework, 107–109; transfer of power over direct sales from Ministry of Privatization to FNM, 115–116; tunneling and asset stripping, 118; voucher privatization system under ¸ Carnogurský government (1991– 1992), 105–107; VSŽ and the Slovak way of privatization, 111–112 Slovenia, 45 Slovnaft, 128 Smerek, Ján, 130 Smith, Adam, 1, 10, 36 SNS. See Slovak National Party Socialist Party of Serbia (SPS), 179 Solidarity movement, 19, 45 Sonin, Konstantin, 49 SOP. See Party of Civic Understanding Soviet Union, 12–14, 18, 19 Sporofund, 121 SPP (Slovak Gas Industry), 129–130 SPS. See Socialist Party of Serbia Stalin, Joseph, 12 Stark, David, 14–17 State capture, 181; defined, 139–140; and Ukraine, 139–147 State Property Fund (SPF; Ukraine), 145 Steel industry: Slovakia, 75; Ukraine, 8, 135, 148–150, 152, 153, 162 Stiglitz, Joseph, 26, 49, 81, 90–91 Stock market. See Capital markets

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Stokes, Gale, 11 Stra¸cár, Slavomír, 75 Šútovec, Milan, 75 Swain, Adam, 149–150 Symonenko, Petro, 141 Szomolányi, So¸na, 74 Tax arrears, 36, 126–127 Tošovský, Josef, 99 Tóth, Július, 110, 111, 128, 201(n20) Trade unions. See Labor unions T¸ríska, Dušan, 59, 64, 194(n5); emphasis on rapid privatization prior to establishment of supporting legal framework, 66–67, 192(n4); and financial intermediaries, 84–89; and partial reform winners and losers, 96–97; and RMS Systems, 96–97; and voucher privatization system, 66 Tunneling, 89–91, 98, 118, 198(n13) Turek, Otakar, 59, 194(nn 5,13) Tymoshenko, Yulia, 143; and aftermath of Orange Revolution, 162–163; assassination attempt, 156; dismissal by Kuchma, 150; fight against corruption, 162–163, 208(n50); and Orange Revolution, 159; and precursors to Orange Revolution, 205(n13); reforms as deputy prime minister for energy, 148–149; and weakening of president’s constitutional powers, 207(n39) Ukraine, 7–8, 133–164; “clan” terminology, 141, 204(n7); coal industry, 8, 144, 148–150, 152; as competitive authoritarian case study, 134–136, 154–156; conflict between eastern business networks and Yushchenko reform government, 149–150; consolidation of presidential power after 1999 elections, 150–153; corruption, scams, and self-dealing behavior, 53, 139–147, 154, 184, 204(n8); court system, 157, 206(n31); debt issues, 147;

domestic business networks (financial industrial groups), 146, 151, 204(n7); economic failings in early postcommunist era, 140–142; economic growth of 2000–2004, 135, 137–139, 152–154; election fraud, 104, 154; elections of 2002, 155, 157–158; elections of 2004– 2005, 40, 154; and EU leverage, 39; foreign investment, 151, 153, 162, 205(n15), 207(n47); foreign ownership, 147; and global financial crisis of 2008, 162; hyperinflation, 142, 145; as illiberal postcommunist state, 46, 104; incumbents not dislodged in founding elections, 140; investment suppressed by system rigged against smalland medium-sized businesses, 157, 206(n32); macroeconomic stabilization, 142–143, 147; murder of political opponents and opposition journalists, 156; oligarchs’ aversion to further political and economic reforms, 146, 151; opposition to regime from agricultural west and smalland medium-sized businesses, 151; Orange Revolution (2004), 8–9, 50–51, 156–162; Orange Revolution aftermath, 162–163; Orange Revolution opponents, 159, 164; Orange Revolution supported by small- and medium-sized business owners and western agricultural region, 138, 156–162, 164; petty harassment by Security Service, 152, 205(14); and political competition theory, 134–136; politicization of the economy, 150–152; postcommunist trajectory brokered by former communists, 7, 46, 139–140; presidential powers strengthened under new constitution (1996), 141; regime crisis of 2004, 135–136, 138, 155– 162; rent-seeking, 135, 141, 144, 148, 155; and rival modes of

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capitalism, 149–150; and Russian financial crisis of 1998, 147–148; slow progress toward market reforms, 144; split in business class over economic governance, 135–136, 138, 151– 152, 159, 166; and state capture (1991–1999), 139–147; steel industry, 135, 148–150, 152, 153, 162; struggles among postcommunist groups over control of economic resources, 141, 150–151; taxes, 149, 152; Yushchenko government (1999– 2001), 147–150. See also Kuchma, Leonid; Tymoshenko, Yulia; Yanukovich, Viktor; Yushchenko, Victor Ukraine, privatization framework, 47, 144–148, 153, 157, 184, 185, 204(n10); impact of concentrated ownership structures, 147; insiders as beneficiaries of privatization programs, 144, 146, 151; lack of protection for minority shareholder rights, 146–147; privatization of Kryvorizhstal steel mill, 152, 162; reorientation of privatization around cash sales, 146; State Property Fund (SPF), 145; voucher privatization system, 47, 145, 185 Unipetrol, 95 United National Movement (UNM; Georgia), 176 United States, 21, 125, 148 UNM. See United National Movement Vachudova, Milada, 39, 125, 208(n1) Valeš, Václav, 61 Velvet Revolution (1989; Czechoslovakia), 46, 49, 56–58, 63, 133 Vlášek, František, 60, 61, 65 Voucher privatization systems. See Mass-action privatization programs VPN. See Public Against Violence Vrba, Jan, 65, 195(n23) VSŽ. See Východoslovenské železiarne

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VSŽ Selecta, 201(n20) Východoslovenské železiarne (VSŽ; Slovakia), 109, 111–112, 118, 128– 129, 201(nn 20,21), 203(n54) Wagner, Richard, 60 Warsaw Pact invasion of Czechoslovakia (1968), 17, 57 Way, Lucan, 34, 40, 134, 167, 203(n2) Welt, Cory, 178 Wilson, Andrew, 50–51, 148 Women, 14, 191(nn 3,1) Workers: conflicts of interest between worker as owner and worker as employee, 193(n14); Czechoslovakia, 58, 59, 68, 194(n4); hardships of early postcommunist period, 31; hoarding of labor, 15; Hungary, 17; labor unions, 56–58, 68; liberalization in labor markets, 23; limited wage and pension increases, 22, 58, 59; and neoliberalism, 31; participation in privatization limited in Russia and Czech Republic, 192(n11); Serbia, 179; Ukraine, 204(n10) World Bank, 21, 40 Yanukovich, Viktor, 146, 205(14); amnesty pact with Yushchenko, 163; as handpicked successor to Kuchma, 157; origins in industrialized region of Ukraine, 135; as prime minister (November 2002), 152; and regime crisis of 2004, 135–136, 161 YAP. See New Azerbaijan Party Yerema, Anatoly, 161 Yushchenko, Victor, 8; agricultural reforms, 153; amnesty pact with Yanukovych, 163; assassination attempt, 156; cabinet of, 148; conflict between eastern business networks and Yushchenko reform government, 149–150; government (1999–2001), 147–150; no confidence vote (May 2001), 150; and Orange Revolution, 157–160;

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personal contacts with Kuchma’s richest supporters, 207(n36); popular appeal of, 150; and privatization programs, 157; reform crusade stalled in the face of coal and steel interests, 148–150; and Russian financial crisis of 1998, 147; “September massacre,” 163; supporters, 150, 155, 157; and weakening of president’s

constitutional powers, 160, 207(n39) Zagaria, Valentin, 161 Zeman, Miloš, 98 Zhvania, David, 157, 160 Zhvania, Zurab, 176 Zinchenko, Oleksandr, 158, 163 ZRS. See Association of Slovak Workers Zvyahilsky, Yukhym, 140

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About the Book

n this remarkable story of postcommunist politics gone wrong, John Gould explores privatization’s role in the scramble for wealth and power in postcommunist Europe. Gould engages the core debates on privatization. Does democratic development facilitate effective capitalist reform, or vice versa? How do political legacies shape privatization choices? Is simultaneous transition feasible? Offering both new empirical information and nuanced political analysis, his in-depth study reveals a surprising relationship between political liberalization and economic reform.

I

JOHN A. GOULD is associate professor of political science at Colorado College.

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