Privatization of the mining and metallurgical complex of Ukraine has been under way ever since 1992, when the cornerstone law and the first national privatization program were approved. This process truly pepped up in 1995 and was carried out as mass priv

WHY DID PRIVATIZATION IN MINING AND METALMAKING TURNED OUT TO BE SO BAD?

Vladimir KAPALIN, consultant with the Central Committee of Trade Unions

Privatization of the mining and metallurgical complex of Ukraine has been under way ever since 1992, when the cornerstone law and the first national privatization program were approved. This process truly pepped up in 1995 and was carried out as mass privatization involving property privatization certificates till mid-1999. Afterwards, the State Property Fund of Ukraine announced transition to a next stage, that is to say to individual investment-oriented privatization in exchange for money.

The privatization has its qualitative and quantitative properties just like any other complex social phenomenon.

Figures on the mining and metalmaking privatization as of January 1, 2000, are shown in table 1 below.

Table 1. Ukrainian mining and metallurgical institutions and establishments by types of property

Table 2. Privatization of mining and metalmaking companies

Table 3. The state of privatization in Ukraine’s major economic sectors as of January 1, 2000

At this point of time, privatized companies employ 393,100 people or 85.1% of the total people employed in Ukraine’s mining and metalmaking. Privatized industrial factories account for 83.6% of the total commercial product output of the mining and metallurgical complex. Therefore, a weighty public sector has already taken shape in the Ukrainian mining and metalmaking. Its quantitative performance, e.g. the number of companies, the rates and depth of privatization, are nothing but impressive.

However, the results of these adjustments are quite far from being unambiguously favorable. After the privatization, the industry has truly worsened its manufacturing, economic, and financial performance.

Sure thing, not all the inauspicious economic and social transformations were caused directly and only by the privatization itself, though a number of them definitely depended on the privatization process.

What has in fact happened? Why did the reforms in the mining and metalmaking yield such depressing results?

To understand the qualitative side of privatization and its social and economic consequences, one should firstly draw the line between the good intentions and high words of the privatization’s inspirers, and the actual results and aftereffects experienced. Quite often, these things are rather different, while in certain cases they are exactly the opposite.

The ideologist adherents of the privatization argued that there was no other alternative because of the disadvantages of the planned administrative-command economy. Here are the most frequently mentioned deficiencies: domination of the one and the only State ownership; poor efficiency of the State in control of the economy; suppression of private initiative and entrepreneurship; technical and technological backwardness compared to the capitalistic society; poor efficiency of the public sector; low labor productivity; lack of true labor motivation for workers; low living standard of the population compared to the capitalistic economies.

Together with price liberalization and giving freedom to local companies to run domestic and foreign-trade business on their own, the privatization was proclaimed a strategic course and the main instrument of economic reforms.

As it had been defined, the privatization had the following chief objectives:

to find efficient and responsible owners that would manage property with higher returns and greater productivity than the State could;

to raise investments in modernization and structural adjustment of the economy;

to enhance cost-efficiency of businesses;

to create a competitive environment and encourage demonopolization of the economy;

to let millions of people become true owners, respectively giving them a labor stimulus;

to set the necessary prerequisites for the living standard improvement.

Since it is necessary to make use of objective and adequate criteria when summing up the privatization results in Ukraine’s mining and metallurgical complex, it seems rather natural to accept the criteria of how well Ukraine has managed to meet the objectives and the tasks of privatization, which were defined in applicable national programs.

Well, as a mater of fact, none of the mentioned tasks has actually been solved in the mining and metal industry yet.

The efficiency of economic management did not go up. Vice versa, it is the privatization that broke down the system of State management over the industry and damaged the control mechanisms.

Yet, it is clear that the mining and metallurgical complex is a tangled industrial and technological system (because its elements are inter-related and dependant on one another), which requires coordinated efforts of its constituent divisions and individual companies, evened-up outputs, and internal cooperation.

Today, this industry is the place for business of three different types of companies, namely, state-owned, private, and mixed ones. Well, the State is not bothering itself anymore with regulation over the latter two types of companies, which in fact make up 87% of Ukraine’s total number. Management and control powers that once used to be held by state agencies have now been restrained considerably or assigned to numerous executive authorities, notably, to the relevant industrial ministry (prior to its liquidation), the State Property Fund of Ukraine, the National Agency for Management of State-Owned Corporate Rights (prior to its liquidation), regional state administrations (i.e. local authorities), proxies, and owners.

Way too many controlling authorities and fragmented managing powers actually turn the industry into nobody’s property. In other words, no one bears the true responsibility for what is happening in the industry.

Moreover, the authorities’ approach rests on the false principle that "the State can not be an efficient owner", which has been long ago disproved by the global practice. The country has become the place for implementation of a purposeful policy founded on the percept that the less the State participates and influences the economy, the better it is. As a result, a true industrial anarchy dominates in the mining and metallurgical complex of Ukraine. This industry has become free of managerial influence of the State.

All this is taking place despite the fact that today’s realities and, above all, experience of the developed economies clearly and convincingly prove this percept wrong. Delivering a report entitled The State in the Changing World, even the World Bank drew a conclusion that the degree of national economic development directly correlates with the scope of State regulation of the economy.

Hence, what we need now is not to deprive the State of the power, but to change the essence of the State’s economic functions. In case of market economy, the State’s role does not wane, but becomes transformed; while during the transitional period the executive influence should even become stronger. Obviously enough, the country’s authorities should switch their efforts from diminishment of the State’s influence upon the economy to enhancement of its efficiency! The Ukrainian State simply must discharge its social obligations, namely, do strategic and tactical planning, economic programming, simulate and forecast economic processes, account for and control over resource flows, regulate and coordinate business activities.

Bearing all this in mind, it seems a little too early to abandon industrial regulation and adopt functional management of the economy before the basics of a viable market economy are in place. Today, the mining and metallurgical complex has an urgent need in a governmental agency that would hold enough power to directly manage state-owned companies, and coordinate and regulate business efforts of private undertakings.

Privatization has failed to stimulate more efficient business of both individual companies and the industry as a whole.

If one draws a comparison between the recent business activities of state-owned and privatized companies, he will have to admit that the generally poor efficiency figures of these two types of businesses are very much alike. In a number of cases, privatized companies even do much worse. The draft National Program for Development of Ukraine’s Mining and Metallurgical Complex till 2010 highlights this feature stating that, "Analysis of privatized companies’ activities does not confirm their advantages over state-owned enterprises".

During the years of reform, almost all the performance figures of the industry have changed for the worse. The 1999 output of principal products, such as commercial ore, coke, iron, steel, and rolled steel, was twice as low as that in 1990, while production of steel tubes and articles made of metal was four times and seven times as low respectively. Thus, all the hopes that privatization would bring a recovery have turned out to be a delusion.

Back in 1991, profitability rates reached 20.9%, while in 1997-98 profitability plunged to the negatives. Mainly owing to the economic experiment under way, profitability of this industry climbed to 7.3% in 1999. Companies have run into a tremendous shortage of in-house current assets, which totaled 6.6 billion Ukrainian hryvnyas as of January 1, 2000. The amount of accounts payable surpassed the amount of accounts receivable by the overwhelming 11.8 billion hryvnyas. Investment resources of companies themselves (i.e. depreciation charges and profit) are exhausted, while mining and metalmaking assets are more than 55% depreciated now. There has been kicked off a progressive destruction of these tangible fixed assets.

Therefore, the current moment clearly proves that alteration of the types of ownership does not guarantee high manufacturing efficiency or investment attractiveness of a company.

With only a few rare lucky exceptions, the new proprietors who emerged as a result of the privatization have failed to manage property more efficiently and more responsibly that the State did. A lot of them acquired shares in exchange for property privatization certificates for further speculative deals on the stock market. Therefore, these people are not interested in investments, rapid renewal of manufacturing facilities, and actual recovery. In fact, they are nothing but pseudo-owners per se.

Intermediary trade firms registered in Ukraine or in offshore zones (i.e. in tax havens) form the second group of new owners. These guys have locked their business on trade in raw materials, fuel, power, and end products. Taking advantage of barter, tolling, and other types of transactions, these owners severely exploit the mills that they own. Predominantly, what they are interested in is to transfer the Ukrainian companies’ current assets and profits to their bank accounts. Some of them have already put together significant capitals and now start to invest some of this money in the privatized enterprises.

The third group of owners, namely, foreign strategic/industrial investors, has turned out to be extraordinarily minuscule. Just a few mining and metalmaking companies, such as public joint-stock company Donetsk Metallurgical Works (Donetsky metallurgiyny zavod), private JSC Zaporozhye Iron Ore Works (Zaporizhsky zalizorudny kombinat), and Sverdlovsk-based joint venture Intersplav (Lugansk region) have been purchased by this type of owners.

The reforms conducted did not nourish a sane competitive business environment either.

Before the reforms, the directive-planning economy was infested with monopolism to the limit. Therefore, as monopolist companies acquired business freedom under condition of a compete absence of any control, the essentials of competition and open pricing did not come into being, but, to the contrary, the monopolized market and monopolistic prices have emerged. Furthermore, in the Ukrainian business conditions, intermediary monopolies appeared next to industrial monopolies. As an outcome, the economy has become much more monopolized.

The implemented privatization model has encouraged neither a widespread attraction of strategic investors, nor raising of vitally important investments.

At the same time, the industry desperately calls for huge investments. According to the draft National Program for Development of Ukraine’s Mining and Metallurgical Complex till 2010, companies will need a total of some $17.4 billion of investments during this period, i.e. the investment demand reaches $650 to 850 million per year. The inflow of investments largely determines how effectively the companies will function, how well they will be able to upgrade and re-equip their manufacturing facilities, and solve social problems of their staffs.

Unfortunately, the State has yet to create a favorable investment climate. Consequently, investment in the Ukrainian mining and metalmaking is slack and faces many difficulties.

The process of enterprise sales under investment commitments of share purchasers has yielded little or no effect. The State Property Fund of Ukraine reports that only some 18% of Ukrainian mining and metallurgical companies have been privatized under condition that their owners contribute investments. Privatization plans of these companies schedule investment of $160 million and 70 million hryvnyas until the year 2002.

On average, the true investments are made only in every tenth privatized mining company and metallurgical mill of Ukraine.

As of January 1, 2000, mining and metallurgical companies received just a negligible amount of direct foreign investments, namely, $93.4 million were obtained by the iron & steel industry, while the nonferrous industry got $37.7 million.

One can clearly see how deep the gap is between the actual investments and the true investment demand of this industry.

The share of investments made in mining and metal industry in the cumulative investments in Ukraine and the rank of this industry in the applicable investment rating give a telltale illustration of how "attractive" indeed the industry is for foreign investors. So, the iron and steel industry has received only 3.3% of the total foreign investments made in Ukraine and ranks the 8th in the investment rating, while the nonferrous industry did even worse with 1.2% of the total and the 14th rank (see Business Ukraine (Dilova Ukrayina) newspaper, issue No.8/2000).

At the same time, there are several good examples of investments coming from the new owners, namely:

MetalsRussia has successfully executed a $55 million investment project on upgrade of electric arc furnaces of Donetsk Metallurgical Works;

the $9.18 million investment contributed by REMET-ALL has been spent on thorough reconstruction of joint venture Intersplan;

Slovakia’s joint-stock company Minerfin (the main owner of Zaporozhye Iron Ore Works) has invested about $18 million to purchase Swedish and US mining equipment. This has doubled the productivity of tunneling efforts, and created healthy and comfortable working conditions.

Small investments have also been made in several other companies.

Yet, these cases are the exceptions to the rule. The industry is in a deep investment crisis. Such a state of investment affairs disallows the enterprises to adapt to the market relations, do qualitative renewal of tangible fixed assets and technologies, run structural adjustments of manufacturing facilities, and enhance product competitiveness in the long run.

Finally, the privatization has turned out to be a great disappointment for employees of mining companies and metallurgical mills. All the declarations of the people’s privatization and people’s capitalism that were made by privatization ideologists have proven to be nothing but populist catchwords. When it came to distribution of the public wealth, privatization rudely trampled social justice and explicitly infringed upon the workers’ rights and interests.

After the privatization, individual shareholders who work for their companies and staffs have become purely nominal, not actual owners. Employees of privatized companies who contributed their labor efforts to create the bulk of these companies’ assets have obtained an unfairly low portion of this property during the distribution procedures. On average, employees of mining and metallurgical companies hold 5 to 15% in their enterprises, though there are several cases when this portion is below 1%.

This situation has been brought about by a number of factors, particularly:

from the very beginning, companies subject to privatization were under-assessed, and the par value of property privatization certificates and compensation certificates was not properly adjusted to inflation rates further on;

the law imposed a limit that workers had a right to acquire shares at par value in the amount not greater than 150% of the par value of a property privatization certificate.

As a rule, Ukrainian mining companies and metallurgical mills are big enough and their assets have high book values. Therefore, employees were able to get only a symbolic trifle of these assets.

Small stakes keep the employed shareholders away from participation in management and control over their companies. This actually means that thousands of employees take completely no part in managerial decision-making.

Besides, somewhat secret and nontransparent management and absence of control over the industry’s higher authorities have nourished broad opportunities for various types of reciprocal setoffs that artificially make the companies suffer losses. This has deprived the employed shareholders of their dividends and degraded motivation of labor. Moreover, any motivation of productive labor has been completely dashed by an almost fivefold reduction in real wages compared to the pre-reform times, and protracted drags in actual payment of the accrued wages in a number of companies.

It has turned out that the economy gets little or nothing from pretentious proclamations that workers are the owners of productive assets without giving them the true rights and opportunities. Meanwhile, public support of the reforms is a necessary precondition for success of these processes.

Therefore, this analysis of privatization’s objectives and tasks proves that most of the issues have remained unresolved in the mining and metallurgical complex of Ukraine. Aside from failure to settle the old economic problems of the industry, the privatization has given rise to new, more acute and painful troubles.

The problem with intermediary companies has gained paramount importance because these businesses are way too numerous, hold much power, and exert unfavorable influence on business as a whole.

During the past decade, intermediary firms have cropped out all around large and medium-sized mining companies and metallurgical mills. Today, these firms have full control over supplies of the necessary materials (e.g. raw materials, power, and component parts) to industrial factories and over sales of marketable end products. Taking advantage of barter, tolling, and other transactions, intermediaries overprice the materials supplied and purchase back the underpriced end products. Subsequently, these end products are sold at the international markets at world prices.

At each stage of the commodity flow, intermediaries earn a 20 to 50% or even greater margin. These huge amounts find their place on offshore bank accounts or stay in Ukraine for a while and get exported further on. Experts estimate that some $3 to 5 billion are annually exported beyond Ukraine like this.

During the years of reform, the scope of intermediary business has become so great that it has turned into a nationwide economic phenomenon. This is why some of the experts insist that the today’s Ukrainian economy has been purposefully transformed into an abnormal and pathological one, where the key roles are not played by manufacturers and consumers (as in case of the developed countries), but rather by an artificial link of intermediary businesses. Owing to unequal exchange transactions, intermediaries have turned industrial factories into mercilessly exploited milch cows.

This has become possible because the authorities and business in Ukraine are not separate as they are in the civilized countries, but stay together. Most often, intermediary firms are set up by executive authorities or by people related to authorities, with direct or indirect participation of the companies’ top management. These people are extremely interested in business prosperity of intermediary firms, because the latter give a reliable and almost inexhaustible source of primary capital.

Certain experts put it this way, "The reasons for the aggravating recession in domestic metal industry are clear enough, namely, the upper managers benefit more from business with trading companies than from making gradual efforts to move their enterprises into recovery. As a result, the industry simply scares investors away and attracts criminals" (see Investment Newspaper (Investgazeta) issue 16/1999).

The existing types of business relations between industrial factories and intermediaries are the main reasons for escape of current assets, delays in wage settlement, and lack of profits (the main source of financing for social benefits).

In this situation, the problem of unprotected rights and interests of employed shareholders (the so-called ‘petty’ investors) has become quite urgent today. Many joint-stock companies infringe upon the basic shareholder’s rights mentioned in the effective law "On business associations", namely, the right to get information on company’s business and financial performance, the right to participate in allocation of profit and get some of the profit as dividends, and the right to participate in management of a joint-stock company.

This is caused by several factors. On the one hand, the staffs have accumulated only insignificant stakes in the course of privatization and even these shares are scattered among numerous petty stockholders. On the other hand, the laws establish no principles of protection of the minority’s rights and interests or amenability for violation of these rights and interests.

The situation with staffs further exacerbates because shares tend to escape from the privatized companies. Large shareholders and intermediary companies that work on their behalf actively buy out the shares of almost all attractive companies from employed shareholders. The objective pursued here is obvious, i.e. these people want to get full control over the company by paying little and bothering themselves with no investment commitments.

It is no wonder that the unfavorable economic consequences of such a privatization have truly revealed their destructive nature in the social sphere, causing an abrupt deterioration of workers’ social protection.

When the State exerts no control, owners mainly try to reduce costs at the expense of wage earners. Labor has become the cheapest productive resource. In fact, this resource is largely underpriced compared to its true value.

Privatization of the mining and metallurgical complex also features a gradually amplifying trend towards dismissal of workers and more severe unemployment problems. Compared to the 1990 figures, the number of production workers employed in the iron and steel industry lowered 13%. At the same time, Ukraine succeeded in avoiding large-scale and mass-discharge dismissal. Most managers and owners of both state-owned and privatized companies tend to retain the core working teams.

However, making efforts to artificially restrain dismissal of employees, owners have to make use of underemployment, thus giving life to a considerable concealed unemployment. Curtailment of working (business) hours of a day or a week and sending employees off on unpaid vacations are the frequently practiced methods in this case.

Owing to privatization, the social-related assets of industrial companies gradually become more deteriorated, while in a number of cases these assets have already been completely destroyed. New owners lack the necessary finance or have no intention to accept such a burden as maintenance of the social sphere. Without proper financial backup, all the attempts of the State to transfer these assets to local authorities are made in vain. As an outcome, the amount of social, cultural, and personal benefits given to workers has shrunk considerably. In the new business environment, employers do not reimburse similar expenditures of their workers any more.

Therefore, summing up the analysis of economic and social outcomes of the privatization in mining and metal industry, one can draw a single conclusion that these outcomes are nothing but unfavorable from the workers’ viewpoint. No economic reforms, regardless their good intentions and objectives declared, can be treated as a success if they lead to a sharp recession in output and deterioration of economic performance and social benefits.

All the prerequisites are in place to make a conclusion on a complete failure of the privatization concept, on inconsistency of the privatization policy pursued, and on deficiencies of privatization-related laws and by-laws. Moreover, the privatization practice has been more than corrupt, based on personal or group interests of higher authorities.

Foreign experts have also arrived to similar conclusions and appraisals. For instance, specialists of the German Consulting Team working with the Government of Ukraine believe that privatization in the CIS was purely nomenclature and gave birth to mixed venal types of ownership, which now impede free competition and encourage business crime (see Transformation of the Ukrainian economic model (in Ukrainian), page 57. Published by Logos in Kiev in 1999).

Whether we like it or not, this privatization was in fact the legal way to transfer the former state-owned property to selected individuals representing the former authorities without any favorable effect for the country’s economy. This enormous redistribution of the wealth of nation in favor of a scantly part of the population, not some favorable social results, has turned out to be the true objective of the privatization.

This privatization has nourished a legal environment for primary accumulation of capital in hands of a limited number of individuals. In a word, wanting to do well, we made the same mistakes again.

Commentary

Below, you can find the Market Reforms Center’s analysis of the results and outcomes of mass privatization in Ukraine.

Ukraine’s mass privatization has three stages, each one of which features its specific methods and approaches. At the first stage (in 1992-1994) employees leased or purchased state property. Altogether, over 1,200 non-agricultural entities were privatized (this figure considers the cases when at least 70% of shares of such companies were sold). Privatization was initiated by managers of the companies involved. Ownership titles were transferred to private shareholders and stayed illiquid, while capital stocks were indivisible.

The second stage (1995-1997) embraced sale of shares in joint-stock companies mainly in exchange for property privatization certificates. This process took in some 2,600 companies representing different industries. This time, the Ukrainian government initiated the process. As a consequence, property became a divisible and liquid asset.

During the third stage (starting the second half of 1997) large stocks have been auctioned off in exchange for money. By mid-1999, some 500 entities had been privatized this way. The Ukrainian government served as the initiator aiming to raise revenues to the country’s budget.

Privatization of the agro-industrial complex is a whole separate issue. From 1992 till 1995 employees privatized roughly 1,230 state-owned companies by buying out their property. About 4,000 businesses were privatized with application of a mixed approach, when the 50% interests were granted to agricultural companies for free.

Based on this, experts with the Market Reforms Center draw a conclusion that privatization of large and medium-sized Ukrainian companies was spontaneous and inconsistent, with frequent violations of the privatization laws and methods, and with selective preferences brought about by political lobbying. Meanwhile, there was no privatization infrastructure for a rather long while, namely, from 1992 till 1995. Owing to all this, it took a long time to establish the essential post-privatization institutions, e.g. corporate management, property accounting, asset restructuring, accounting for stocks and securities, and so on.

The present depth of Ukrainian companies’ privatization (i.e. the percentage of shares realized) is not enough to attract market capitals in reconstruction and rearrangement of domestic businesses. On the whole, the 56.1% stakes in medium and large enterprises have been sold so far. In selected cases, namely, in the fuel and power industry, metal industry, chemical and petrochemical industry, average privatization depth hardly exceeds 35%. Companies with 70% and more shares sold account for only 40.3% of aggregate stocks in Ukraine’s privatized companies.

At the moment, state-owned companies make up 54% and privatized companies hold 16.7% of the total corporate equities in Ukraine. Starting 1995, it has become an annual paramount craze to privatize large and medium-sized companies only. Consequently, as of mid-1999, the corporate sector of the economy comprised 6,500 partially or fully state-owned joint-stock companies. This number makes up 58% of the total corporate sector of Ukraine.

As it turns out, mass privatization has failed to sell the bulk of state property to private owners. This trend is especially strong in raw-material-extraction industries. Insufficient privatization depth makes the majority of new corporations and privatized companies trail behind in terms of reorganization and recovery.

Some 66% of the privatization were performed by transfer of ownership titles to employees and managers free of charge, including 47.4% done in exchange for property privatization certificates. Roughly 25% of shares in all the companies subject to privatization were realized at certificate auctions. Only 9% of stocks were sold in exchange for money.

The majority of Ukrainians holding 75% of property privatization certificates virtually took no part in the privatization. Mass privatization has come to grief trying to give birth to an open stock market, while investment funds and speculator institutions have had no access to most securities.

The Market Reforms Center (Tsentr rynkovykh reform)

the Metal