The Governance Grenade: Mass Privatization, State Capacity and Economic Growth in Post-communist Countries

Why did the transitions from state socialism to capitalism result in improved growth in some countries but significant economic declines in others? Three main arguments have been advanced: (1) the most successful countries rapidly implemented privatization, liberalization, and stabilization policies; (2) failures were unrelated to economic policies but occurred because of a poor institutional environment; and (3) the policies were counterproductive because they damaged the state. We present a state-centered theory which argues that the more radical the privatization program, the worse the subsequent performance. We agree with the second account, that institutions matter, but demonstrate that it was radical privatization itself which was a major determinant of institutional weakness. In addition, our account holds that privatization was in fact a crucial determinant of institutional failure, operating primarily through the creation of a massive shock to state revenues. We perform cross-national regressions for a sample of 30 countries between 1990 and 2000, and find that mass privatization programs negatively impacted economic growth, state capacity and property rights protection. These findings are corroborated with data from a random sample of 4,000 firms from 26 post-communist countries. We show that in countries which implemented sizable mass-privatized programs, privatized firms were substantially less likely to engage in successful industrial restructuring but considerably more likely to engage in barter and have tax arrears than their state owned counterparts.