Lacking detailed analyses by international consultancies, Romania can still draw a few lessons out of other country reports. This is the case of a recent report by McKinsey on Russia’s troubles in its transition efforts, which so far appear fruitless.
Analogies with Romania’s domestic situation, as much as that is possible, are worrying, but they can also lead to solutions in those problems which are similar.
In short, the McKinsey experts analyse the ratio between the ownership structure and the promotion of financial discipline, and also discuss the most suitable sequence for the two operations – whereas the World Bank suggests that changes in the ownership structure will not have the expected positive results until financial discipline becomes a reality, the McKinsey report delivers a different opinion, but still agrees that the two issues are more than just correlated. An overview of the arguments put forth by the McKinsey analysts, due to the similarities with Romania, can prove useful.
Put simply, what the McKinsey paper calls the fundamental shortcomings of the Russian economy are the lack of investments and the lack of corporate government performance – that is, the absence of a motivational structure that generates economic performance.
The situation in Romania does not differ too much from that in the economy which has, after all, imposed its model for over 50 years in the entire region. The bright side is that similar problems can suggest some common solutions.
Where we stand with investments
Foreign investments as a monthly average at the beginning of the year have fluctuated around $4 million, according to the National Statistics Commission, which in its sober figures delivered the ridiculous truth – about 20 cents of investment per capita.
These are the regular months, without figures inflated by spectacular transactions such as the privatisation and re-privatisation of Petromidia, which occasionally gives the illusion that investors are not forgetting Romania.
In the last ten years, Romania has had the lowest rate of gross investment among former socialist countries, except for Bulgaria. In 1993-1996 alone, gross investments have grown, and the year 2000 is expected to bring more good news.
Still, in real terms, investments in the Romanian economy are 120% against the 1989 levels, whereas in the most advanced countries, they have grown much more than 100%.
The lack of domestic investments is caused on one hand by the lack of domestic capital, but also by the lack of motivation for domestic investors to make long-term investments.
Legislative instability is most often cited, but the attractiveness of short-term investments is also worth considering.
This means not only that investments in government bonds have a better yield than any long-term investment could dream of offering, but also that investments in the real economy, most often in the grey or barely legal areas, are made on a short-term basis to avoid taxation or for fear of missing out on favourable opportunities.
Suspicious tenders held by state companies are also occasions for the sudden emergence of companies which, with minimum investment and in a brief period of time, provide an enviable profit rate.
Focused on such opportunities, domestic funds, as well as management capacities, are losing their focus on long-term investments.
Of course, banks’ lack of experience and motivation to lend into the real economy is an argument that is often cited, and therefore less interesting. Privatisation via shareholder certificates is also a valid argument which is blamed for Romanian companies’ lack of financial resources.
Still, in Romania’s case, the situation is not as dramatic as with Russia, where managers often became the shareholders of their own companies.
Corporate government
A sophisticated but essentially simple term, corporate government has remained a subject of colloquia in Romania. At one point, as an anecdote, the Government intended to include the term itself, “corporate,” into a few emergency ordinances, but, aware that the law does not make any express statements to that effect, abandoned the intention.
Still, simple as it is, the law that governs the activity of economic agents allows an insight into the structure of interests and decision making mechanisms by which those interested in a company’s life impose their will (in a simplified version, this would be a rudimentary decision of corporate government).
The virtual economy, a term used by the McKinsey analysts for relationships based on barter, bills or tax collection in kind, is not strange to the Romanian economy.
The recently promulgated ordinance 95/2000, on the payment of taxes in kind, as well as the sophisticated natural gas excise system (essentially, also in kind) are just two examples. Debt restructuring, arrears between companies and bonds issued by Conel, in fact quasi-money, are other elements capable of distorting the structure of interaction between sides interested in a company’s activity.
The result is that those who make the decisions have no interest in maximising the long-term value of the business. The lack of a capital market, the only one capable of evaluating a business, makes the concept of maximisation itself an illusion.
What’s more, the emergence of less legal mechanisms of extracting financial flows outside the company further distances the model from the ideal. In particular, three traits have been identified by McKinsey as characterising corporate government in Russia – all three with a striking familiarity to the Romanian reader.
The first is managers’ insecurity, due to their lack of competence, which leads to a restrained horizon of action. The second trait is the lack of a mechanism to materialise the company’s value (the capital market or any other property transfer system), which in this case has no further need of being maximised.
Only least, there comes the taxation system, which makes it much more economical to extract financial flows from other venues than that of profit.
Debt to shares
The solution found by McKinsey for Russia is that of converting arrears into shares – but with some delimitation. First, only the conversion of debts towards the state is efficient, and second, the operation must be carried out by a private agent.
The two threats to this mechanism, which have been long debated in Romania, are the fact that current management or private investors capture the company, and corruption, favoured by the lack of transparency.
In the former case, as in many frequent precedents in Russia, loans from state banks, seen by the officials as privatisation facilities, do nothing but transfer arrears from the budget to the banking system.
Contracting loans from the state to buy shares in privatised companies has been a model of failure in the first stages of privatisation in Russia, and these precedents must be carefully considered when granting the much-touted facilities to Romanian companies.
The second threat mentioned in the conversion of debts into shares is corruption, which is potentially present in any privatisation effort but is encouraged by the high degree of sophistication.
This is the reason why McKinsey suggests that fiscal arrears should be turned over to private agents who, before converting them to shares, will hold tenders for the right to own them.
But McKinsey does not consider the third factor that imperils the proposed solution (conversion) – the lack of state interest.
The structure of post-socialist corporate government, in which the state, political forces, state officials, company management, have no interest in dealing with the problem, makes a solution that needs a concentration of will difficult to achieve.
Imposing financial discipline, or restructuring (or privatisation), that is, approaching the problem from a single position, seems a better solution, although perhaps not the best. This may be the reason why the conversion of claims to shares has not gone beyond project stage in any of the post-communist states.