Privatization Fails to Fulfill its Promise in Developing Economies
Efforts to close the efficiency gap between domestic firms in developing countries and those in advanced economies have fallen well short of expectations.
ANN ARBOR, Mich.—Despite efforts to promote privatization, competition and other economic reforms, domestic firms in Russia and the Czech Republic have been unable to close the efficiency gap with world standards.
A new University of Michigan business school study of industrial firms in those countries reveals that policies pursued during the Washington Consensus period have not enabled domestic companies in either country to begin catching up with the world standard for efficiency set by foreign-owned firms.
(The Washington Consensus is a set of policies believed to be the formula for promoting economic growth in Latin America. It was first presented by John Williamson from the Institute for International Economics in 1989.)
Most important, privatization to domestic ownership—a major pillar of these policies—has not provided a means for domestic firms to start closing the gap, say Ross School researchers Jan Svejnar, Katherine Terrell and Klara Sabirianova Peter. They add that foreign-owned firms are displacing local firms in developing economies.
"The gap between foreign and domestic firms' efficiency is much larger in Russia than in the Czech Republic, but it is growing in both countries, and at a faster rate in Russia," said Svejnar, the Everett E. Berg Professor of Business Administration. "This suggests domestic firms in Russia, and to a lesser extent in the Czech Republic, are increasingly falling behind the world efficiency standard. This lag has important implications as globalization expands and worldwide competition intensifies."
The study estimates and compares changes in the levels of productive efficiency from 1992 to 2000 for foreign-owned firms and three types of domestic firms: state-owned enterprises (SOEs), privately owned companies and firms with mixed ownership. The estimated efficiency of the best foreign-owned firms serves as a benchmark for the world standard.
The researchers say that the efficiency of the private and mixed-ownership firms in both countries is, on average, similar to that of the SOEs, indicating privatization did not have its intended efficiency-enhancing effect. They also found that neither the more-efficient nor less-efficient domestic firms have been capable of reducing the efficiency gap over time, thereby dispelling the theory that firms closer to the world-technological frontier are more likely to succeed than those further behind. Finally, they say that foreign firms are nudging out domestic firms in the upper end of overall efficiency distribution at a faster rate than they are increasing their numbers in the overall population of firms.
The efficiency gap in the Czech Republic is smaller than in Russia, in part because the Central and East European (CEE) model of transition and development emphasizes opening up trade and capital flows, developing a relatively functioning market economy and gradually establishing institutions, rules and regulations that make a country eligible for accession to the European Union. In contrast, Russia and other countries in the Commonwealth of Independent States (CIS) remain more closed to world trade and foreign investment and have been slow in modernizing their laws, regulations and institutions.
"To the extent that competition and legal and institutional development complement privatization, one may expect domestic firms to become more efficient and to approach the world standard faster in the Czech Republic than in Russia," Svejnar said.
The study results suggest that domestic firms in both economies are unable to close the efficiency gap because they are slower in acquiring productivity-enhancing knowledge than foreign firms and because domestic startups tend to be less efficient than foreign startups. In addition, foreign investors tend to acquire the most productive domestic firms, producing negative spillover effects on local competitors.
"Countries in both regions continue to face the challenge of how they will ensure that their firms approach the world efficiency standard," Svejnar said. "The Czech Republic and other CEE countries are meeting this development challenge by rapidly increasing the share of gross domestic product accounted for by foreign firms. Russia and other CIS economies have not yet started to meet the challenge, which will become especially acute as they enter the World Trade Organization."
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