Volume 10 Number 4

Fall 2001

Feature: A Symposium on Bulgaria

The Path of Bulgarian Economic Reform
Krassen Stanchev

The history of economic reform in postcommunist Bulgaria demonstrates that overused analytical dichotomies-left/right, Keynesian/ Friedmanite, and the like-confuse rather than illuminate the nature of actual policies. As a rule, the phrase "leftist policies" is used to denote forms of intervention best described by C.-F. Bastiat: higher taxes, restricted freedom of contract, granting more rights to labor, and an increased role for government mediation. In Bulgaria, however, both leftist and rightist governments have displayed a preference for regulatory policies that are hard to pinpoint on the left-right spectrum. For Bulgarian politicians, as for politicians elsewhere in the postcommunist region, the real choice in transition policies was and still is to regulate or not to regulate, what to regulate, and how. And the major lesson of the Bulgarian economic transition is that the functioning of networks of trust and the pursuit of rents in a concrete institutional environment are factors whose significance far outweighs the role of the ideologies allegedly espoused by political actors.

Economic policy
The reforms in Bulgaria did not get under way until February 1991. Their purported objectives were rather typical in an East European context: financial stabilization, reduced inflation, and control over money aggregates and budget deficits; prompt privatization of state-owned enterprises (SOEs); fostering promarket behavior among economic actors; and effective and coherent public governance.¹ The very words used to characterize these policy objectives seem borrowed from such distinguished reformers as Poland.² At the same time, though, the level of political support for meaningful economic change was very different. In Poland the reformist program figured prominently in the agenda of political forces, while in Bulgaria it remained an orphan; no political party was willing to push for its implementation.

During the first eight years of Bulgaria's postcommunist transformation, the only approximate reform success came in 1993-94, when the government-which included some economic experts-managed to reduce the foreign debt by 47 percent. A few months later, however, this cabinet was forced to resign by the former communists (now renamed the Bulgarian Socialist Party [BSP]) who soon thereafter won the general elections and formed a new government. The backbone of their economic policy was the continued subsidizing of the loss-making public sector. In 1995, 57 percent of SOEs were producing losses, representing 15 percent of the GDP; two-thirds of the total losses were created by 60 enterprises with a combined employment of 85,000. Since the government's ability to borrow was extremely limited (the foreign debt ballooned to 130 percent of the GDP, the economy registered no growth, the banking system was collapsing, and hard-currency reserves were rapidly squandered), its options were limited. Adamant about continuing their support for the failing SOEs, the government embraced the only solution that was available: printing more money and then using price controls as a substitute for control of money supply in order to channel funds in politically desirable directions.

This strategy proved to be unsustainable; by the end of 1996, Bulgaria's financial system had disintegrated, and monthly inflation had skyrocketed to triple-digit values (242 percent in February 1997 alone). In 1997, there were two ways to stop the hyperinflation: either to "dollarize" or to fix the exchange rate and restrict the government's power to issue currency by creating a currency board. No political party supported the former but all the major ones backed the latter. As a result, the country switched to a currency-board regime in the summer of 1997.

The major proreform party, the Union of Democratic Forces (UDF), was believed to be the true champion of austerity measures. And its policies did, indeed, differ from the BSP's policies in at least two respects: the UDF reduced the number of controlled prices and closed loss-making enterprises. But the implementation of the first step was not really a matter of choice; it was an inevitable aftereffect of the restriction of the government's power over monetary policy. Moreover, as Table 1 indicates, it is obvious that the liberalization at the end of 1990s was less radical than that of 1991. With regard to the second step, there was again little room for maneuver. Under the circumstances, the only options were restricting the loss makers' access to credit, liquidation, and/or sale. Hardly surprisingly, privatization emerged as the most acceptable strategy, a strategy endorsed by all parties regardless of their ideological leanings. Eventually, the supposedly rightist UDF wound up implementing privatization policies designed by leftist governments.

Reform beneficiaries
Why did economic policy in Bulgaria fail to prevent a series of protracted economic crises and to reduce the social costs of transition? In order to answer this, one should focus first on a preliminary issue: Who are the beneficiaries of the economic reforms as they were actually implemented in Bulgaria in the early 1990s? The country's mode of participation in the international economy in the 1980s is particularly important with regard to this question. During that period, Bulgaria was in a position to explore various rent-seeking possibilities by serving as a mediator between East and West. And, as is the case with every rent, a group of entrepreneurs emerged ready to capitalize on the rent opportunities.

The modus operandi was as follows. The Bulgarian government established companies abroad to sell energy resources and recycled raw materials (bought at subsidized COMECON prices) on the international market. The price difference went to support communist regimes throughout the world and buy products the West had embargoed for sale to communist countries. The shell companies then resold these products in COMECON. (The initiative was launched as a result of a confidential decision by the communist government, which was coordinated with other Warsaw Pact governments in 1984. It sanctioned the development of small and medium-sized enterprises and of a special credit line to support their economic initiatives.) The nature of these businesses required that they operate via subsidiaries. The creation of these companies coincided with Bulgaria's peak accumulation of foreign debt. Facing the disappearance of the COMECON market, the last communist government of Bulgaria unilaterally announced a moratorium on its foreign-debt payments, in March 1990. In 1991, the first reform year, the Bulgarian foreign debt amounted to 150 percent of GDP and 271 percent of the exports.³

These business activities, in turn, led to the emergence of strategically located groups of party officials with access to Western corporate and financial know-how. During the early stages of the Bulgarian transition, these individuals retained their power and influence. They became experts in siphoning off funds through company networks without leaving any trace or paper trails. As a result, the very same cadres who had been indoctrinated to believe that capitalism is a form of theft were the ones who quickly became Bulgaria's nouveau riche. The most salient feature of this group was the high level of trust among its members-a feature that sets them apart from all other groups in postcommunist society. The fact that they could trust each other allowed them to reap numerous benefits. For example, these cadres quickly infiltrated the fledgling banking system, obtained access to coveted export quotas and government contracts, set up large private business empires, and played a key role in financing political parties and individual members of parliament.

The driving forces behind the ideas
Some of the most visible and characteristic patterns of Bulgaria's economic policymaking may be described in the following way: overregulation of private property and a lack of rules regulating the use of depositors' and taxpayers' money. A comparison of the legal arrangements in the financial sphere with the rules pertaining to private business and labor relations in the private sector sheds light on the question of who stands to benefit from this pattern of policymaking and why.

Private banks began to emerge in Bulgaria in 1990 and continued to mushroom until 1993.⁴ It would be fair to say that this process unfolded in a legal vacuum. There were virtually no barriers to entry-the founders of the banks did not even have to declare the origins of their capital, and as a result most of the new financial institutions were started with borrowed funds. The number of private banks increased significantly, from 2 in 1990 to 70 in 1993, consolidated to 26 in 1995; their share of total bank assets was 3.1 percent in 1992, 22.4 percent in 1995; eventually 18 banks were closed after 1996. A bankruptcy law was not adopted until 1994; creditor rights were never effectively enforced; and foreclosures could last de jure at least 19 months, and de facto much longer-an absurdly long time in an inflationary environment. These banks opted to extend credit to inner circles of friends and often resorted to informal contract fixers, that is to say, criminal associates. Delayed restructuring, lack of financial discipline, and widespread soft loans, combined with attempt to stabilize the situation through so-called measured emissions of new money, constantly transferred costs to the general public.⁵ The price of this moral hazard was estimated as 14 percent of the 1997 GDP.⁶

The emerging private sector
In vivid contrast to the laxity that characterized the financial sector, entry into the nonfinancial sector was difficult, originally, because of old communist-era regulations and attitudes, and, later, it became increasingly difficult due to new regulations. Table 2 shows the increase in the number of permits established by legislation in the transition years.

This table shows that the rise in regulation and red-tape is not tied to the ideological makeup of the government. The two most significant increases in the number of permits (in 1995 and 1997-98) coincide with radical changes in the government: from a loose coalition to a socialist-dominated regime, in 1994; and from socialists to the UDF, in 1997. While the government, since 1997, has abandoned some policies that affect the macroeconomic environment, it has expanded its role in direct regulation of business activities through the increased scope of licensing and registration requirements. On various occasions, new licensing regulations are justified as a necessary part of the process of harmonizing legislation with the laws of the European Union. But it is obvious that, more often than not, the likely motivation behind such policies is the interest of administrative officials who benefit from the government's continuing interference in private transactions (every new hurdle creates an opportunity to demand or receive a bribe). The result is that, in 1999, the private sector's costs of complying with government regulations amounted to 12 percent of GDP. Under these circumstances, the emergence of private businesses as legitimate participants in public debates was also hindered.

Labor and social protection
Part of the freedom to engage in business is the freedom to use one's own labor as a source of capital. Presumably, rightist policy ideas would seek the reduction of a company's labor cost, while leftist ones would aim at imposing more costs on entrepreneurs. Taxation of labor and welfare contributions is a special case of regulation of private business. In Bulgaria, there is clearly a trend toward ever more comprehensive regulation throughout the entire period of transition and regardless of the political ideology of ruling majorities.

The right column of Table 3 shows the employer's total cost to put 100 Bulgarian leva in the pocket of the worker; these costs have been rising for nine years. The overall increase of labor costs imposed by different governments is mainly due to the social-welfare system. Policymakers have sought to ensure higher revenues through increasing tax (that is, contribution) rates. The institutional outcome for the economy was the perpetuation of incentives to plunder. Coping with prohibitive rates of welfare contribution meant fewer and fewer legally employed workers, and higher and higher unemployment rates over the years. Moreover, in order to maintain informal employment, businesses were compelled to collect more revenue through unregistered activities and thus the scope of the gray economy was expanded. Employers and employees often come to an agreement to seek tax-evasion schemes jointly. This constellation of interests supports anti-rule-of-law corporate and employee behavior, erodes public trust, and motivates the government to resort to questionable interventions that often constitute a violation of property and privacy rights.

The SOEs' political consensus
The prevalent policies toward SOEs in Bulgaria reflect the irresistible appeal of arrangements that allow strategic constituencies to live at others' expense, as well as the perverse consequences of such arrangements. Governments have repeatedly and readily delayed the liquidation of socially sensitive SOEs, while at the same appointing political friends and public servants to management boards. Bankruptcy regulations were not even applied to SOEs until 1997 in order to allow workers to keep their jobs. Private banks were happy to fund SOEs and then, using the argument that they serve presumably important social interests, to apply for refinancing from the Central Bank. In the meantime, through the use of private companies as suppliers and distributors (owned by both banks and managers of SOEs), the profits generated by the public sector were privatized, while the debts were dumped on the budget.

Throughout the post-1989 period, the choice of both left- and right-leaning politicians was to leave the public sector underregulated. Ministers acted like the sole proprietors of the SOEs; they appointed managers and board members at their discretion; nor were there rules regarding competition requirements, outside contracting, or the use of venture-capital schemes. Until 1998, there were no rules about how many boards on which public servants or legislators could sit. Six cabinets, each with a supposedly different ideological makeup, did not touch this system, and its negative impact reverberated throughout the entire economy. Loss-making enterprises were finally closed in 1999-2000, but even after that the pressure for soft loans and quasi-fiscal subsidies continued, and important privatization deals were aborted.

Contract "enforcement"
The state's reluctance to reassert its monopoly on coercion opened a gap in the public order, which was filled by private organizations. Bulgarians call them "wrestlers," a general name for racketeers and violent entrepreneurs who sell protection. The industry originated in Bulgaria's success in wrestling and weight lifting in the 1970s and '80s. The communist-era ministries of interior and defense managed the best clubs. The athletes had army and police ranks and often constituted a pool of future employees for these ministries. When the government's sport subsidies disappeared in 1990, there was a vast supply of idle athletes. These men and their handlers subsequently established companies whose primary area of activity was protection of property and personal security.

Besides guarding offices, warehouses, and individuals, the major services these companies provided also included "motivating" parties to accept contractual terms imposed by an initiating party, "monitoring" the loyalty of contractors, and "convincing" people to meet the terms of business deals. In order to increase the demand for their services, they had to induce violence in society and create various forms of criminal entrepreneurship from scratch. An attempt in the mid-1990s to regulate these quasi-mafia organizations forced them to reregister as insurance companies and to advertise themselves as "investment businesses." (As was the case with banking, the insurance industry enjoyed a long period of free entry and remained without any specific regulation until April 1998, when the 1997 Insurance Act was implemented.) An IME survey from 1996 on private-sector transaction costs found that 35 percent of private firms in big cities across the country had an informal protection contract.8 In fact, we are dealing, here, with an attempt to privatize the use of force in a society where law-enforcement agencies chronically malfunction. A rational response on the part of voters concerned about this trend has been to endorse demands for a stronger state, which, in turn, could easily lead to the rise of intrusive, possibly overweening, government.

Privatization
The Privatization Law (originally adopted in April 1992, and subsequently amended 27 times) allows for a wide degree of discretion in the selection of buyers. It can be implemented via tenders, direct negotiations, public offerings of shares, and auctions. Institutions in charge of individual privatization deals decide on a case-by-case basis which sale procedure to employ. Direct negotiation is the least regulated method, yet it is the most frequently used procedure. According to available data, in fact, the percentage of auctions compared to the total number of deals contracted by both the Privatization Agency and the directly involved ministries in 1998 amounted to a mere 6 percent. It may be interesting to contrast this figure with analogous figures that come about with the application of open privatization procedures, as in Hungary, where auctions account for nearly 70 percent of all the deals.⁹

In Bulgaria, there is a pattern apparent for bigger enterprises, where auctions are used more frequently in privatization procedures but not for more than 20 percent of the sales through the Privatization Agency, while "selection of a strategic buyer"-as a technique-tends to prevail in smaller deals conducted by ministries and principals.¹⁰ Insider dealing became even easier in 1997, when the Privatization Law introduced a special regime for management-employee buyouts (MEBOs), which enables teams composed of managers and workers to purchase an enterprise if they make a 10 percent down payment and schedule payment of the remaining 90 percent of the price over a ten-year period.

Between 1993 and 1998, MEBO sales amounted to 44.3 percent of the total number of privatization deals. The percentage is close to Russia's record sales to insiders and is, in large part, due to the actions of the proreform government that came to power in 1997. Indeed, in 1998, the figure jumped: 73.4 percent of the deals involving the sale of SOEs were signed with MEBOs (in 1999 and 2000 the percent dropped to 33 percent, partly as a result of increasing public pressure for transparency). This system of preferences was gradually dismantled in 2000 and 2001. The evidence does not suggest that MEBOs thrive only under certain types of governments, say, those led by socialists. The UDF cabinet, considered center-right and reform-minded, also used this technique, arguing that it is a part of the general process of scaling down the public sector. In fact, at least in 1998, privatization sales to MEBOs was an explicit attempt to redistribute the right to resell former SOEs to managers appointed by the cabinet itself.

Conclusions
If we relate the policies described above to the sequence of changing governments, it would be difficult to sustain the view that leftists (i.e., the BSP) are led by ideas about redistribution, whereas rightists (i.e., the UDF) are willing to launch promarket reforms. The choices actually made by policymakers do not display a strong affinity to particular political value systems.

The choice not to regulate sectors dealing with "other people's money" was neither Keynesian nor Friedmanite. A leftist government would opt for more labor protection and more rights for insiders in the privatization process. But in Bulgaria the policies of the allegedly right-of-center government were identical to those of the left-wingers. Barriers to private-sector development were erected by all governments; and, whether intentionally or not, they protected the privileges of those who had first emerged as capitalists.

The legacies and constellations of relationships of the first transition years have established a dubious political and institutional environment. Perhaps this environment, and not the analysis of political ideologies, better accounts for the substance and direction of economic policies. The continuing domination of trust-based networks perhaps explains why the emergence of an institutionalized legal framework and the societal (impersonal) trust, which renders possible the emergence of genuine competition, was hindered, and why the economic opportunities were exploited by an extremely limited number of actors. In fact, in Bulgaria, social groups that relied on formal rules and procedures were systematically marginalized and constantly lost out. This is one of the consequences of delayed institutional reforms, nontransparent modes of privatization, and the alienation of foreign investors.

The consequences for political behavior are equally important. There is a general feeling that reforms have been unfair and are designed to benefit semiformal interest groups. The majority of those who have found that they were unjustly disadvantaged, during most of the transition years, expect a central-government subsidy as compensation or simply move into the informal sector. Fledgling political parties have few options but to seek their own clientele and take recourse, yet again, in politically dependent state-owned enterprises. The clientelistic behavior of incumbent governments was somehow excusable for the voters, given that there was an understanding that the "newcomers" should purge "old crooks" who had already looted the people. Voters, especially supporters of the newcomers or at least those disappointed by the old-timers, were most of the time even ready to tolerate some lack of transparency. It was this public tolerance of unfairness, more than the peculiarities of the local culture, that explains who won what and how as a result of the dynamic process of property redistribution in postcommunist Bulgaria.

Krassen Stanchev is a cofounder of Transparency International Bulgaria, executive director of the Institute for Market Economics, and a former member of the Bulgarian parliament.

Notes

1. See Ventzislav Antonov and Roumen Avramov, eds., The Year of the Iron Sheep: Bulgarian Economic Reform in 1991 (Sofia: Agency for Economic Coordination and Development, 1992).
2. See Waclaw Wilczynski, "Five Years of the Polish Transformation: 1989-1994," in Five Years after June: The Polish Transformation, 1989-1994, ed. Jan Winiecki (London: The Center for Research into Communist Economies, 1996), p. 24.
3. BNB Annual Report 1991, p. 30.
4. I do not discuss here fiscal accountability. However, some remarks are necessary. For a significant period, as one would suspect from the discussion that follows, there were numerous incentives to postpone fiscal transparency. Here are some examples: the law on compiling the state budget was not adopted until 1996; government-debt statistics only became available in 1997-98; the consolidated budget was published only in 2000; and the criteria for distributing subsidies to municipalities are amended every year.
5. A detailed description of the money-transfer mechanism may be found in Roumen Avramov and Kamen Guenov, Rebirth of Capitalism in Bulgaria (Sofia: AECD, 1995).
6. See Gerard Caprio and Daniela Klingebeil, "Bank Insolvencies: Cross-Country Experience," The World Bank (Washington, 1996; unpublished). See also 1999 OECD Economic Surveys: Bulgaria (Paris: OECD 2000), p. 59.
7. A more detailed picture can be found in Administrative Barriers to Investment in Bulgaria (Foreign Investment Advisory Service, February 2000); see also "Licensing Requirements in Retail and Wholesale Trade and Commercial Road Transport Companies," IME Newsletter 7, nos. 1-2 (2000), pp. 2-11.
8. "Barriers to Free Enterprise," IME Newsletter 3, nos. 7-8 (1996). The cited IME publications are available at: www.ime-bg.org.
9. See Maria Dezserine, Accessibility and Transparency of the Public Procurement Process in Hungary, Albania and the Slovak Republic (Budapest: FME, 1998).
10. For details, see Luisa Perrotti and Krassen Stanchev, "The Role of the Core Executive in the Privatization Process: Country Report on Bulgaria." This is an unpublished report of March 1999 for the OECD/SIGMA and the World Bank.

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