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. Last Updated: 07/27/2016

The Wrong Avenue to Privatization

Nikolai Travkin, a deputy in the Russian parliament, has launched an experiment in privatization in his hometown of Shakovskaya that is fundamentally flawed and should not be a blueprint for privatization in Russia.

Travkin's plan differs from the mass privatization program now being implemented by Deputy Prime Minister Anatoly Chubais in that it simply gives the workers all shares in their enterprise. The worker-shareholders do not have full property rights over their shares, however; the shares cannot be sold to outsiders and a worker loses his shares if he quits.

Under the Chubais version, workers are given the chance to buy some of the shares in their firm, often at a discount, and then the remaining shares are sold to outside investors. Shareholders own their shares without restraint. Shares can be bought, sold and offered as security against loans.

The problem with Travkin's approach on the first point is more a matter of human nature than economics.

Simply put, people do not value things they do not pay for.

Workers and investors who have bought their shares at voucher auctions know how much they have paid, and they want to see some return.

They are aware of other uses for the money and in many cases they will borrow extra money to purchase their shares. This gives them a stronger incentive and in some cases compels them to make their companies run as profitably as possible. It will mean restructuring, closing down loss-making businesses and taking risks.

The second difference is more technical but just as damaging.

Since workers do not have the capacity to buy and sell their shares, they will be excluded from the range of normal financing options available to owners of property.

It is harder for firms to take on debt because the shares of the company cannot be offered as security for loans. It is harder to engage in joint ventures, attract outside investors and raise new capital.

Fundamentally, "shareholders" who cannot sell their shares on the free market have no interest in seeing their company prosper in the long term, since they will not benefit if the share price rises.

Travkin's misguided plans would have only curiosity value except that the Russian parliament is now threatening to put them into effect on a much bigger scale.

Parliament is discussing amendments to the privatization program for Russia that run roughly parallel to Travkin's scheme. This could have serious consequences.

Privatization must provide real ownership changes with full property rights.