"Real Estate and Investments. Legal Regulation", the journal

Issue 1, 1999

Change of Forms of Ownership in Moscow and Social and Economic Consequences of the Process

Zholkov À.S., academic of the Academy of Natural Sciences

The main goals of privatization were making public property private, & forming a class of private proprietors.

Privatization in Russia is the most important way of coming to the market economy. At the same time the privatization is the most complex social & economic program. The distinction of privatization in Russia is very short terms. It has been taken several centuries to form proprietors’ class in other countries.

Next distinction is that most people in Russia didn’t have enough money to get realty. The situation got worse after price liberation that depreciated people’s savings. It is socially important today to give people rights to receive property for money because now they can legally invest money in real estate. An economic power in our country will be divided according to the amount of different groups’ investments in realty.

Next distinction of Russian privatization is that people hardly knew what to do with their property. It happened because people were not ready to live in the market economy. There was no long period for forming the market infrastructure (stock exchange, economic statistics, audit, and market laws).

Economy decentralization started in 1998, when the State refused to control capital in the material production. Actually, capital owner is the one who manages revenues.

The Law “about state company ”, June, 1987 gave directors a strong power. The Law said, “Self-government system is managed by the company’s director. He manages all activities & organizes the work of the company. The director also manages company’s property, makes deals, opens check, and other kind of accounts in banks”. It was allowed for the first time to establish cooperatives in State companies by the Law. It said: ”cooperatives can be established in a company & the company takes park in cooperative’s activities”.

Since 1988 independent from the State companies’ directors have been taking over the right to direct income from goods’ producers. Now Capital turn & capital saving depend on the directors. The State mostly stayed out of the investment process. First, non-government cooperatives, small companies, joint companies & other commercial structures were receiving little amount of production income & then it was rising.

To the early 1992 large capital had already been in the private economy sector. It had happened before official “privatization” started. Capital transfer from the state economy sector was provided with high-quality staff transfer to the private sector where they were suggested higher wages.

In the early 1992 economy liberation freed prices & wages, & let companies’ managers & workforce pull the capital out of material production for their own needs. The Government was continuing to give capital to industry, agriculture, construction, etc., but income was distributed by companies’ directors & workforce. State capital was becoming capital of trade middlemen’s & financial usurers’ especially when commercial banks appeared. In other words, there were other ways of making state property private besides the official “privatization”.

Moscow was a pioneer of the privatization in Russia.

In November 26, 1991 Moscow’s Mayer Gavril Popov signed the Act ¹222 which defines a special way of a service sphere “privatization”, based on giving property to workforce. This way of privatization differed from the one that was defined in the Law “State companies privatization in Russian Soviet Federative Socialist Republic”. According to the Law the State property was supposed to be distributed on auctions.

The Act ¹222 contradicted the Normative Act “Moscow property privatization” that was signed in September 26,1991. It was important & interesting document. Questions of the “privatization” beginning period were considered as a whole for the first time in regional practice. The documents considered social & economic responsibility of full process.

Moscow Soviet confirmed Regulations about two Authorities that were responsible for realizing the change of property forms in Moscow. They were Property Fund & Property Management Committee. There were clear stated rights & responsibilities of the institutes, & their mutual relations in the Regulations.

Capital Legislative Authority appointed Property Control Commission in the Duma for vetoing owning decisions that violated laws.

It is important to tell, from the very beginning the process was supposed to be socially oriented. It was based on the special program to exclude illegal deals & acts.

The Sixth paragraph of the document ordered the Moscow Government to work out & present a “privatization” program for the confirmation before October 15, 1991.

The Eighth paragraph of the document also played an important role: “Suggest the Moscow Government (Luzhkov Yu.M.) to consider carrying out ##2, 3 in the Regulation of RF “about named “privatization” accounts & deposits in RF” for providing social justice & moscovities participation in the privatization.

However, named accounts were replaced with deprived of assignment securities. That caused criminal & illegal privatization.

The Privatization is a public, political, social & economic process. Making property to be state or private depends on a particular situation, goals of development, a political power & a social attitude.

Legislation documents included simple & clear scheme for everyone. There is the gist of it: they take a property to own; forecast an amount of money from its selling; invest no less than a half of it. Therefore a middle class could have been formed step by step. People could have had enough money to start their own business. It is not late yet, the situation could be changed according to the legislation.

It happened differently in a real life. According to the Act ¹222 state companies were given to workforce almost for free without auctions.

In November 28, 1991 Mr. Luzhkov presented another position of privatization in Moscow. In his opinion, the main point of privatization was not selling the property, but capitalizing the profit, that is a “business privatization”. This kind of the privatization requires profit evaluation, stability in getting the profit & perspective of its rise. In Luzhkov’s opinion property cost including buildings & land should be a part of a market price. Unfortunately, in the late 1991, in the early 1992 this approach was not realized.

In December 29, 1991 special Decree ¹334 of the Russian President was signed. It’s named “Additional Power of Moscow Governing Authorities for the period of radical economic reform”.

The Decree of a Moscow executive authority’s president gave a right “to fast property reforms in Moscow using its own rules & a schedule”.

This document gave a new impulse to the default of the Moscow “privatization”.

In January 12, 1992 the President signed the Decree ¹16 “about the fast state property privatization in Moscow”. The document confirmed the owning order in trade, everyday services, public restaurants, business.

The documents listed above set the starting auction price that equals to 1000 rubles per 1 sq. m of real estate, the document also define an auction as the main way of “privatization”.

The Decree about fast privatization of state companies in Moscow has some norms contradicted with legislation. In particular third paragraph they change Moscow Property Fund functions leaving just control over the “privatization” process.

Practice showed that this change has made the process more complicated.

Authorities started issuing documents confirming property deals’ legality such as: buying-selling agreements, property certificates,-without having had rights for that. Then a new proprietor had problems to make commercial transactions (to get a credit from a bank, etc.), because it was hard to confirm the legality of his property.

Representative & executive authorities were getting requests to regulate the “privatization” process.

There was judicial contradictory situation that loosened the control over the process & favored corruption. Foreign investors were less interested in participation in Moscow economic reforms.

Authorities’ withstanding reduced the competition. It influenced the price decline in selling state property.

There was a meeting of all authorities’ branches together with Moscow businessmen in January, 1992. They worked out principles of joint activities to carry out economic reforms.

It was essential to carry out the “privatization” according to the City Program, the Law, equal participation of the Property Fund & Moscow Property Committee in the process.

The “governmental Program of Privatization in 1992” played an important role. It obliged local authorities to issue their own programs.

In November 4, 1992 the Moscow Soviet issued the first City Privatization program. The principles of the 1992 Program were prolonged for 1993.

New original tendencies had been appeared in the practice of the Moscow privatization since 1998. They were reflected in the program of 1995-1997 “State Property Privatization in Moscow”. It was signed by the Moscow Duma as the Decree ¹61 in September 20, 1995. The Program included 398 enterprises in industry, science, construction, transport, communications, energy, trade, etc.

In spring, 1997, Moscow Suma made the list longer by 226 items.

We should tell the Program was realized. The Moscow privatization way distinctions were the following:

  • Commercial competition with terms of investment was the prior way of selling limited companies’ shares, & owning real estate;
  • Real estate evaluation was made according to the market price;
  • The land, where premises for the “privatization” were situated, was not being sold. It was being ceased;
  • In 1995-1996, receipts, issued instead of “privatization” checks, were used as means of payments for property. The receipts were reserved under the 31st form by “Sberbank”.

Privatization was held according to the specific industry.

F.e.: energetic companies were required to leave major interest in federal property. According to the Food Department suggestion there would have been fifteen objects’ shares in the amount of 15-45% from each one left in Moscow property for 3 years.

The Moscow Property Committee had registered 559 private companies for the period since 1995 to 1997. Today there are 102 companies in the process of “privatization”.

It was received over 1,5 trillion rubles. In the early 1998 it was received about 7 trillion rubles.

Here is another important issue. Unfortunately, the normative & legislative bases were confused & contradicted, but they were large. The “Privatization” was regulated by the State Programs, Presidential Decrees, Governmental Acts, State Property Ministry’s Acts, the Laws.

Serious law violations & important social, economic miscalculations were admitted in the “privatization”.

Normative base was being approved in a hurry to carry out a political objective, t. e. to form a proprietors’ class. Normative documents were often signed with violations of legislation procedures.

The State Programs of the “Privatization” contented small number of limits for owning objects. Most enterprises in different industries including defense were allowed Russians & foreigners to be owned.

It was not legal to issue special securities, called “voucher”. The Law “about named accounts & deposits in RF”, July 3,1991 defined another way of people’s participation in the “privatization”, t. e. named accounts of citizens in Russia.

However, the Presidential Decree ¹914, august 14, 1991, ordered to issue bearer checks, t. e. deprived of assignment. The mess had been started since then. “Vouchers” with the nominal value of 10000 rubles were traded at much lower prices on a free market.

Here is another important moment. The State Property Committee made auction rules that did not limit amount of shares per every “voucher” bought. So, an auction rate depended on the number of applications. It was possible to get a package of shares for a “voucher” if a single buyer sent an application.

The Presidential Decree ¹721, July 1, 92 obliged state companies to transform into public limited companies with the following share selling to private persons. This gave nothing but criminal to most companies.

Cost evaluation of owning object

Considering the “Privatization” as the process it is important to have a mechanism that lets evaluate different aspects of it. The mechanism should be clear to help logical & analytical conclusions be transformed into calculation language. Key moment is to work out methods of lost profit evaluation.

Nowadays, State property evaluation is being made according to the remaining cost that is calculated by reducing balance cost by property “wear & tear”. “Wear & tear” is calculated according to amortization norms at the moment of evaluation.

In the USSR Finance Ministry’s materials of 1990 contented mane approaches to property evaluation. There were evaluations according to remaining cost, balance cost, & to assumed company’s income. According to the RF Law, July 3, 1991 “about the State companies privatization in RF” the main property evaluation was evaluation according to assumed company’s income. The reason why they made it prior is that remaining company’s cost is often very low, but profits are high, because of high demand for the company’s goods on the market.

That’s why an appropriate property evaluation is the one based on assumed income or how it is also called profit capitalization. It is the only possible way of share cost setting when there is no strict exchange evaluation. Income calculation is required because they should pay dividends to shareholders. However, there are other ways of buying out or distributing a property. Therefore we need also evaluate property & its real cost taking income into account.

Evaluation is not a dogma, but orientation to setting the selling price. Of course there are variants. And one of them is discount of possible income through a coefficient that corrects remaining cost. Applying property evaluation to realty objects will let increase starting selling prices & fulfil the city budget.

What is the gist of profit capitalization method? When they evaluate an object they compare its cost with income amount that comes from a bank deposit.

The logic here is simple. Any object has its own income. Even if costs are equal income amount is different. So, evaluation cost should not be less than this amount.

The Presidential Decrees ¹366, January 29, 1992, and ¹721, July 1, 1992 set cost according to the remaining property evaluation by a balance.

Prices existed before 1991 were taken as a base. It’s clear, in the conditions of inflation those prices were much lower than real property costs.

But Decree ¹1535 of the Russian President, July 22, 1994 gave a possibility to increase starting selling price on auctions. However, many objects had been already sold by 1994. Property had been sold for trifling sum for two years.

That’s why there is a practical interest in comparing two property evaluation variants: one is by remaining cost & the other one is by capitalized profit. The difference between results is an amount of a lost profit. When we calculate the lost profit we use the following categories:

  1. Disposable cost of capital goods.
  2. “Wear & tear” coefficient of basic funds.
  3. Remaining cost of basic funds
  4. Profit received by the industry.
  5. Companies’ profitability.
  6. A Minimal bank deposit.
  7. Capitalized industry profit.
  8. Share of goods, produced by private companies in the industry.
  9. Real evaluation cost of private companies in all industries including the one we are analyzing.
  10. Lost profit in the process of the state property evaluation.

To calculate the lost profit we should take into account the following conditions.

Let’s take 1993 as an analyzing period. In 1993 most companies had become joint stock ones. Basic capital goods’ cost in Moscow made 800 billion rubles in prices on the first of January, 1994 (disposable cost). In Moscow “wear & tear” coefficient of basic funds made 38%. Remaining cost of basic funds equaled 496 billion rubles.

Profit in the Moscow industry made 1,6 trillion rubles in prices of 1993. Therefore in 1993 industry’s profit was two times more than disposable cost of capital goods, & three times more than remaining cost of basic funds.

However, profit gotten in 1993 can be calculated differently. In 1993 it was gotten 0,66 ruble of profit per a ruble. So, profit made 528 billion rubles (800 billion rubles * 0,66) in prices on the first of January, not 1,6 trillion rubles.

Capitalized profit calculation’s method suggests to take into account average profit for the past five years. The method is to use in a stable economic situation. In real economic life it has been a reduce in outputs for the past five years. For instance, only in 1993 industrial productivity reduced by 12%. That’s why there is a drop in profits. Industry profit in 1993 would be less than a profit for the past five years in capitalized profit calculations. Minimal bank deposit in 1993 might be taken at the level of 80%. So, in 1993 capitalized profit made 496 billion rubles. The evaluation according to capitalized profit made 660 billion rubles.

Industrial goods produced by the private industrial companies in Moscow in 1993 made 60%. In 1993 Capitalized profit evaluation of private companies made 396 billion rubles in the conditions of equal profit distribution between state & private companies 86% out of an private companies became private in 1993. Consequently, capitalized profit evaluation of those companies made 340 billion rubles. Real evaluation cost of all economic branches’ private companies was 22,4 billion rubles in 1993; an industry share was less than 10% & that is 2,2 billion rubles.

In 1993 lost profit in capitalized profit evaluation was over 338 billion rubles.

These calculations in private companies cost evaluation were made without taking inflation into account. Let’s take real profit in capital industries into account when we calculate the lost profit. In 1993 lost profit was 1,6 trillion rubles & that was three times more than the real profit.

Considering those results we draw a conclusion that in the real economic situation a new factor has appeared since 1992. It had been inflation that influenced State property evaluation costs. Inflation strengthens the necessity in state property cost evaluation in case of buying the property out according to its possible income. There are most important factors in these conditions such as: company’s financial situation, company’s profitability, demand for goods & services, the place where company is situated, perspectives for economic development & changes.

Formal property evaluation according to remaining cost does not take inflation & those factors into account.

Even “Temporary methods in state property cost evaluation “ issued by the Finance Ministry in 1990 took inflation into account. In particular, it says: “When buying or selling by installments company’s property annual payments should include a rise in property cost in accordance with a price rise, bane credit interest, inflation, etc.”

Other normative documents ignored variety of state property evaluation methods & the real economic situation. The inflation was also ignored. But as it is known the inflation has a great influence on the state property evaluation. Consequently, it is necessary to neutralize the inflationary factor in the possible state property evaluation.

An amount of lost profit considering inflation is increasing more than three times & reaching a trillion of rubles in current prices.

These arguments proved by the particular numbers & taken from the reality let us draw curious conclusions.

It is enough to compare industrial objects’ costs (according to remaining cost) with the evaluations gotten in the process of “privatization” for arising the main question why did the incredible difference take place? We suppose, there was lowering in capital goods’ cost & highering in “wear & tear”.

All of these calculations have an evaluation’s character. The results give us a clue about numbers’ order in the lost profit evaluation of the industrial property “privatization” in Moscow. Evaluation of the state property cost without capitalized profit is evidently lowered. Only profit evaluation, stability of its getting, perspective of its rise let set the real market price for state companies.