The Great Giveaway Revisited

“Behind every great fortune,” wrote Honore de Balzac, “there lies a great crime.”

If the 19th century French playwright’s observation is not an accurate description of how the Ukrainian government sold off the nation’s most valuable assets following the collapse of the Soviet Union, it sure seems that way to many people.

“Scam.” “Ripoff.” “Unfair.”

These are some of the other words people use when talking about the way Ukraine transferred so much of the nation’s wealth to a few insiders at such fire-sale prices. The opaque deals gave rise to a super-billionaire class while many in the nation suffered poverty.

While the transactions may have been technically legal from the standpoint of the corrupt 1990s, the nation paid a dear price. Many argue that the distortions and damage to the nation continue to this day, through lack of honest competition in the marketplace and the financial elite's co-opting of government.

Besides contributing to a profound sense of unfairness, Ukrainians missed out on considerable – but difficult to quantify – privatization revenues that would likely have come from open and competitive bids for state assets. Such a windfall might have lifted everyone’s standard of living and helped create a stronger middle class.

Instead, a dozen or so business groups – led by super-billionaires such as Rinat Akhmetov and Victor Pinchuk -- control Ukraine’s main industries of ferrous and non-ferrous metals, coal, machinery and transport equipment, chemicals and food processing.

Ukraine has more billionaires per capita than Russia, a nation that Forbes magazine ranked as having the third-highest number after the United States and Germany.

All of this concentration of wealth and political power is inherently unhealthy to a society, many say.

Economists call this kind of high-wealth concentration a “capture economy,” which the International Monetary Fund defines as “the efforts of firms to shape the laws, policies, and regulations of the state to their own advantage by providing illicit private gains to public officials.”

“When you have a huge disparity between the 10 percent richest and 10 percent poorest in a country, this is an indicator that a country is unstable from the standpoint that society doesn’t view those with money as being legitimate, that wealth was acquired dishonestly,” said Mykhailo Mishchenko of the Razumkov Center, a Kyiv-­based think tank.

Balazs Horvath, resident representative of the International Monetary Fund in Ukraine, said the non-competitive privatizations of the 1990s created “a significant buildup of inequality in wealth and income.” Consequently, Horvath said, a large and strong middle class – considered the backbone of stable societies -- has yet to form.

'Almost always rigged'

Some 400 enterprises of strategic importance for the national economy and security, according to the State Property Fund, were among those privatized. They were sold at nominal prices via emissions of shares that were scooped up by private hands. Or they simply sold at below-market prices.

Other public-private ownership transfers included rigged auctions conducted unfairly and non-transparently or closed auctions with preconditions that favored a select few investors often excluding stronger competitors or strategic investors.

“These auctions were almost always rigged intentionally to create an uneven and inequitable playing field to keep out higher bidders and was done with approval from the top on the national and regional levels,” said Alex Frishberg, managing partner of Frishberg & Partners law firm, familiar with the privatization process in the 1990s.

Ownership rights to some state-owned enterprises were simply transferred to private hands. Land was leased to individuals who ran companies into the ground in order to later buy them at rock-bottom prices at the state’s expense.

Privatization was lauded by Western experts for two principal reasons. Politically, it was a way of swiftly breaking with the Soviet socialist past. Economically, it was a key step in the transition to a market economy, which should have boosted productivity and efficiency.

“Importantly, the transparency of the privatization process, and efforts to ensure competitive privatization that attracts strategic investors is a critical determinant of how much of these gains actually materialize,” Horvath said. The long-term gains should have led to increased employment and salaries, thus raising the overall standard of living, said Horvath. Only in the past five years has Ukraine reaped the benefits of rising domestic consumption.

But the results are mixed. Some owners became good owners by investing in their companies, others less so, Horvath added.

Ukraine did not initiate “shock therapy” to quickly privatize, unlike many of its central and eastern European neighbors who are now snugly in the European Union and NATO. Privatization was much more of a dragged-out and shadowy affair for Ukraine, as much of the population struggled with poverty. Capital flight became and remains rampant. The offshore haven of Cyprus is still Ukraine’s largest foreign direct investor.

Privatization, moreover, was never fully completed in Ukraine. It has now ground to a halt amid the current political chaos. And land privatization has not begun, due to Ukraine’s socialist leanings on the issue.

Kryvorizhstal example

The poster boy of sloppy privatization is the way Ukraine’s largest steel manufacturer, Kryvorizhstal, was first sold in June 2004, which critics at home and abroad cited as an example of corruption and state property mismanagement.

It was sold for a paltry $800 million to a consortium made up of companies belonging to Akhmetov, who has a net worth estimated at $31 billion, and Pinchuk, the son-in-law of former President Leonid Kuchma. Pinchuk is the second wealthiest Ukrainian, Korrespondent magazine says, with a fortune of $9 billion.

The sale was made even though Mittal Steel offered nearly twice the amount – $1.5 billion.

“Cash privatizations are always a little crooked and shady since the true value of assets is always difficult to ascertain and someone [the bidders] will always be dissatisfied,” said Anders Aslund, senior fellow at the Peter G. Peterson Institute for International Economics in Washington D.C.

That deal was dismissed in court in June 2005 with the moral support of President Victor Yushchenko, who was still riding high after the 2004 Orange Revolution that brought him to power.

Then the steel giant was r-sold by the government, fetching more than Ukraine generated from privatization in the previous four years.

Mittal Steel acquired a 93 percent stake in Kryvorizhstal in October 2005 for a whopping $4.8 billion. The bidding was broadcast live on Ukrainian television.

“Once a serious strategic investor took over the plant and started investing heavily into it, this spurred others in Ukraine’s steel industry to do the same, which is what transparent, competitive privatizations are supposed to do,” said the International Monetary Fund’s Horvath.

Reprivatizations halted

But Kryvorizhstal stands by itself, in the opinion of many, as an injustice corrected. Other major reprivatizations never occurred, despite attempts by Prime Minister Yulia Tymoshenko in 2005 to regain and resell prized assets.

Tymoshenko said she received a list of 3,000 enterprises that prosecutors said were privatized illegally. She pledged to review dozens of sales. Her efforts went nowhere, as her government bowed to fierce criticism for shaking investor confidence. She was fired in late 2005, in part over her attempts to reprivatize Nikopol Ferroalloy Plant, then-controlled by Pinchuk.

The highly valuable Nikopol plant reportedly has 11.5 percent of the world’s manganese alloy market. The government sold a majority stake in the company to a Pinchuk-controlled group in the early 2000s for $80 million, spurning an offer of more than twice as much.

Attempts to renationalize Nikopol have failed, allowing Pinchuk to continue reaping the highly profitable exports -- estimated at some $30 million per month. At that rate, Pinchuk needed less than three months to recoup his initial purchase price.

The most recent glaring example of state collusion with oligarchs was the 2007 privatization of Luhanskteplovoz, Ukraine’s monopoly locomotive producer.

A 76 percent stake was sold in a last-minute auction to essentially a single bidder for $60 million, Russian Transmashholding, the largest producer of heavy machinery in Russia and controlled by oligarch Iskander Makhmudov.

Major European companies eyeing Luhanskteplovoz, included German electronics giant Siemens, with some analysts estimating at the time that the state could fetch as much as $200 million.

The state also expressed an interest in reprivatizing Ukraine’s largest iron-ore mines that once made up the Ukrrudprom state holding company. These include Southern, Northern, Central, Inguletsky and Kryvy Rih ore companies, which together produce 70 percent of this raw material for the country’s steel business and for export.

Their controlling stakes were sold in 2004 to Russian billionaire Vadim Novitsky, Akhmetov and Pinchuk.

The tender was deemed unfair since it was limited to buyers who had already existing stakes in ore companies.

The state’s coffers received $270 million after Ukrrudprom’s sale. In contrast, iron ore plants in Russia individually sold for much more ranging from $600 million (Stoilenskiy Iron Dresser Complex) to $1.7 billion (Ural Steel).

Other cases have been criticized for abuses.

Among them, the buyers of Chornomorsky shipyards and the Zaporizhya Aluminum Plant are accused of non-compliance with investment obligations, giving the state grounds for reprivatization.

One special case is the Mariupol-based Illich Metallurgical Plant. Its first brush with privatization came in 1996, when a 42 percent stake was transmitted through a privileged share transfer to the plant’s 39,000 workforce.

Later, in 2000, parliament and then-President Kuchma approved the privileged sale of a majority stake of the plant for roughly $82 million. Nominally, all the plant’s employees have shares in the enterprise worth billions. Rumors abound that the stakes are controlled by the plant’s top management, namely the plant’s director, Volodymyr Boiko. The plant has a market capitalization of $4.6 billion, according to Invest Gazeta.

Billions of dollars lost

It’s not clear how many billions of dollars the state missed out on because of slipshod or corrupt privatization. Also unknown is how much better off Ukrainians would be if the sales of their nation’s most valuable enterprises were conducted openly and competitively.

After Vladimir Putin came to power in Russia, he famously gathered the nation’s major oligarchs in 2000 and, in a warning to stay clear of politics, lectured them about the crony privatizations that took place under Boris Yeltsin’s rule.

“I only want to draw your attention straightaway to the fact that you have yourselves created this very state, to a large extent through political and quasi-political structures under your control. So perhaps what one should do least of all is blame the mirror,” Putin said.

Many believe the same was true about Ukraine in the 1990s – and is even more so today.