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Private Affairs

Until the Serbian government tackles the socialist-era conglomerates, economic growth and foreign investment will remain elusive. by Ivan Jankovic 29 May 2006 BELGRADE, Serbia and Montenegro | Serbia started privatization much later than most Eastern European countries because socialism – in name or reality – lasted much longer here. Only 12 percent of state or socially-owned capital has been privatized, leaving a whopping 88 percent in state hands or socially owned.

From the very beginning of the transition from communism, two competing approaches to privatizing state-owned companies emerged. The first, dubbed “shock therapy” or “the big bang,” valued speed above all else. Vouchers were given to all adult citizens, and market capitalism left to develop through secondary trading on stock markets and the growth of new enterprises. Speed was of the essence to ensure old communist elites did not recover, consolidate, and return to power. Former Czech Prime Minister Vaclav Klaus was among the most prominent promoters of this approach, which was also practiced to a lesser degree in Poland and Slovenia.

The other, slower approach – adopted by Germany, Estonia, and Hungary – was to sell state enterprises to foreign investors.

A third option, “insider privatization,” in which employees and managers of state enterprises became the majority shareholders prevailed in Slovenia, Russia, Ukraine and also, Serbia.


Serbian privatization began in 1997 under Milosevic and benefited mainly insiders, fueling an internal conflict of interest between owners and employees known in economic theory as the “Furubotn-Pejovich effect.” This refers to the conflict between the natural interest of the owner – to increase profits – and the natural interest of the employee – to increase wages and benefits. If employees are also owners, they will tend to direct profits towards salaries (paid monthly) rather than investing in new production that could increase profits and dividends (paid yearly). A company with insider shareholders is usually much less efficient than a company owned by outsiders.

In Serbia, the firms privatized by the insider method were among the country’s most successful, but most performed poorly after privatization. Knjaz Milos, the famous Arandjelovac-based mineral water and soft drink producer, incurred heavy losses in 2001 and 2002 although its raw material – natural mineral water – was almost free of charge.

A second, closely related flaw of the insider model was its voluntary nature: it was left to the management to decide whether to privatize, and in most cases it was simply not in management’s interest to privatize. It was much more lucrative for managers, as the heads of “social” enterprises, to make deals with private enterprises they owned on the side (or that were otherwise friendly). In that way, a “hidden privatization” took place, transferring capital from state-owned to private firms, and resulting in a form of crony capitalism.

After the overthrow of the Milosevic regime in 2000, the new government passed a privatization law that took effect in July 2001, changing the basic parameters of the process. The concept of insider privatization was abandoned and all firms were to be encouraged, and eventually required, to privatize. The law provided incentives for quick privatization – if a company privatized within one year, it would be allowed to distribute up to 30 percent of its shares among employees, a figure that dropped by 10 percent each subsequent year. This was a variant of the system used in Germany and Estonia, resting on the assumption that a quick sale would increase budget revenues, improve corporate governance, stimulate technological innovation, and open up foreign markets.

The law also anticipated that larger firms would be privatized through tenders rather than auctions.

Implementation quickly ran up against formidable obstacles.

Technically speaking, Serbia’s “social” property was not state-owned but in the hands of employees. In practice, ownership control had been exercised by the Communist Party and people close to its leadership and later by the Milosevic regime. But the Milosevic cronies who ran the show were replaced, after his fall, by people under nobody’s control. The reformist government of Prime Minister Zoran Djindjic proposed that all social enterprises be nationalized then sold, but the trade unions refused, insisting they controlled the assets they had created. Crony capitalism continued.

Another effect of the new law was that enterprises that had begun but not completed privatization during Milosevic’s time now scrambled to privatize as quickly as possible, in order to do so under the old rules. If ownership remained dispersed among a large number of shareholders and employees, managers could secure their positions by threatening workers with dismissal (perfectly legally). The expropriation of minority shareholders was also made possible by other laws, for example the securities exchange law. This happened, for example, in the case of C Market, a big retail chain, whose then-CEO is today wanted on embezzlement charges. For years, he had prevented minority shareholders from selling their shares by refusing to sign the prospectus needed for a stock market listing, giving him time to strip the firm of its assets. In 2005, the company made a profit of only EUR 16,000 on revenues of about EUR 200 million.

Even the success stories -- of which there are many -- have their downsides. Take the Nis-based tobacco company DIN, sold for USD 387 million to Philip Morris in 2003. Celebrated as one of the best deals in Eastern Europe, it was achieved through heavy tariff protection of domestic producers. This increased anticipated profits and the market valuation of the firm and resulted in a budget windfall for government, but meant Serbs would pay more for cigarettes.

Another interesting case is the steel producer Sartid Smederevo, which fell on hard times in the 1990s. A consortium of Austrian banks had been financing Sartid during Milosevic’s time under murky conditions. But when the consortium wanted to take Sartid over by converting debt into capital, it was brushed off by a Serbian bankruptcy court. Instead, the firm was liquidated and sold to U.S. Steel.


Following passage of the 2001 law, privatization closely followed political circumstances. In 2001, only 200 firms were privatized, mainly smaller ones. In 2002, that number shot up, only to fall again when the assassination of Prime Minister Djindjic led to instability.

The current prime minister, Vojislav Kostunica, came to power in early 2004 harshly denouncing privatization process corruption and pledging a thorough review. Branko Pavlovic, appointed head of the privatization agency, suspended privatizations and annulled several lawful tenders, earning him the scorn of liberal cabinet members and international financial institutions. Pavlovic was fired after just a few months on the job. His successor, Miodrag Djordjevic, resumed privatizations but by then, only less attractive firms remained. Fundamentally, the government’s approach to privatization remained the same, notwithstanding Kostunica’s promise of a review.

Privatization has so far bypassed Serbia’s public utilities such as NIS (the state oil monopoly) and EPS (the state power monopoly), as well as big socialist-era firms like the Crvena zastava car factory in Kragujevac.

About 60 percent of Serbia’s workers are employed in its sprawling and unreformed public sector, which produces around 20 percent of the country’s value added. The government shies away from tackling these uncompetitive firms because it fears the social consequences of restructuring and privatization. EPS, for example, traditionally pays the highest wages in the country but has a vast number of redundant workers, especially in administrative jobs. Any restructuring is bound to take privileges away from militant and unionized workers, a nightmare for any government, but especially a weak and embattled minority government that lacks any serious vision of a free market economy and the determination to achieve it.

As for the old giants of the Serbian socialist economy, such as Crvena zastava Kragujevac, the strategy of all post-Milosevic governments has been pretty much the same: “improve” their condition through ample subsidies so that at least some parts of the enterprise become attractive to foreign investors. In 2001, for example, Zastava was split into three firms: the automaker Zastava automobili, the firearms producer Namenska, and the truck maker Zastava kamioni. To date, only Zastava kamioni has been privatized, while Zastava automobili, which employs the most workers, is on standby due to its heavy debt burden.

Every year, the Serbian budget pays enormous subsidies to keep about 30 companies afloat – companies with thousands of redundant employees generating millions in losses. The effects are devastating both for the taxpayers and for the firms. By refusing to liquidate the companies, the government sends the mistaken signal that they are sound businesses for which it is responsible.

The costs of these inefficient enterprises are borne by the taxpayer.

One of the reasons why the privatization of public utilities and socialist-type firms hasn’t proceeded is that greenfield investment – direct investment, typically by foreign investors, in new or expanded firms – has been lagging due to a lack of tax incentives and high barriers to entry. This means redundant workers from privatized state companies have nowhere to go – market-driven companies with existing export channels, good governance, and new technology don’t exist to absorb them. The resulting economic hardship and high unemployment make it harder to proceed to the second step of privatizing public utilities and large companies.

Serbia could have benefited from the various lessons learned during privatization processes in other countries. But 17 years after the fall of the Berlin Wall and six years after the start of real transition in the country, privatization in Serbia has achieved only modest and ambiguous results. In this, it is not so different from other aspects of the transition process.
Ivan Jankovic is a Belgrade-based writer on globalization and political transition.
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