Journal of Economic Studies

Emerald Article: Analyzing the efficiency of Russian firms

Susan J. Linz, Ilya Rakhovsky

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JES
38,4
430
Received 20 October 2009
Accepted 11 June 2010
Journal of Economic Studies
Vol. 38 No. 4, 2011
pp. 430-451
q Emerald Group Publishing Limited
0144-3585
DOI 10.1108/01443581111160888
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0144-3585.htm
Analyzing the efficiency of
Russian firms
Susan J. Linz and Ilya Rakhovsky
Department of Economics, Michigan State University, East Lansing,
Michigan, USA
Abstract
Purpose Did the Soviet development strategy of according high priority to firms in heavy industry
give these firms an advantage during Russias transition to a market-oriented economy? This paper
seeks to answer this question.
Design/methodology/approach To document industry variation in efficiency between priority
and non-priority sectors, the paper uses firm-level data collected in 1992 and 1995 to estimate a
stochastic frontier production function for 11 industries. It then aims to investigate which firm
characteristics contributed to variation in technical efficiency between 1992 and 1995.
Findings Firms in low-priority sectors exhibited higher efficiency in 1992 than firms in
high-priority sectors; by 1995, efficiency differences diminish. Efficiency gains were relatively higher
in industries which experienced the largest percentage output declines. Non-state ownership tends to
improve efficiency, but the ownership effect varies by industry and over time. The paper rejects the
hypothesis that export experience increases efficiency, and this result is especially strong in 1995.
Location in Moscow proved to be a positive factor, and the benefit grew over time.
Research limitations/implications Panel data were not used because near-hyper-inflationary
conditions and changes in capital valuation methods make it impossible to accurately adjust output
and capital values between 1992 and 1995; and because firms that divided into multiple units or
changed industry classification between 1992 and 1995 would need to be dropped, reducing sample
size considerably and making industry-level analysis impossible.
Practical implications The paper provides a baseline for analyzing the impact of the transition
on the performance of Russian manufacturing firms. It evaluates the influence of location (capital city
effect) on firm performance, and demonstrates that privatization alone is not sufficient to improve
efficiency.
Originality/value This is the first study to examine the initial impact of transition on the
efficiency of Russian firms across 11 industries, with focus on differences between former priority and
non-priority sectors. The results underscore the magnitude of structural dislocation caused by
planners preferences in the former Soviet economy.
Keywords Stochastic frontier, Technical efficiency, Transition management, Industry differences,
Plant efficiency, Russia
Paper type Research paper
JEL classification P23, L33, L24, L32, D24
The authors thank Peter Schmidt for helpful comments. Research for this paper was
supported by the University of Michigans William Davidson Institute, the University of
Pittsburghs BURK program, an All-University Research Initiation Grant from Michigan State
University, and a short-term travel grant from the International Research and Exchanges Board,
with funds provided by the US Department of State (Title VIII) and the National Endowment for
the Humanities. None of these organizations is responsible for the views expressed. The authors
are indebted to Kathleen Beegle for her data management assistance, and thank Elizabeth
Harkness, Steven Glenister, Janet Blake and Sarah Linz for data entry, and Michael Morozov and
Victor Sozutov for assistance in acquiring the data used in this paper.
1. Introduction Analyzing the
Did the Soviet development strategy of according high priority to firms in heavy efficiency of
industry give them an advantage during Russias transition to a market-oriented
economy? To date, because the absence of firm-level data has stymied efforts to assess Russian firms
firm efficiency in the Soviet economy, little is known about the incidence and variation
of industry efficiency inherited by Russia (Bairam, 1991; Brock, 1993; Danilin et al.,
1985; Whitesell, 1994). This knowledge gap impedes analyses of the transitions 431
impact. We address the gap using firm-level data collected in 1992 and 1995, defining
advantage as firms exhibiting best-practice production outcomes.
Two objectives govern our analysis. First, we document industry variation in firm
efficiency at the beginning of Russias economic transformation. Given economy-wide
structural distortions, under-developed market institutions, and severe macroeconomic
instability caused by Russias shock therapy, our analysis focuses on technical
efficiency generating maximum output from a given set of inputs. Technical
efficiency is best suited for this study because it can be analyzed independent of firms
objectives, which is an important feature in an economy experiencing rapid mass
privatization. More specifically, we investigate whether firms that received
high priority in the Soviet economy were more likely to exhibit industry
best-practice production methods in 1992, and whether the efficiency pattern within
and across industries varied significantly by 1995. Second, we investigate whether
ownership, export experience, or location in Moscow contributed to variation in
technical efficiency during this period. We focus on Russias Central region[1] because
it allows us to hold constant other factors that might influence performance (climate,
transportation, regional level of development, and so forth).
Why analyze industry differences in technical efficiency at the beginning of
Russias transition? While somewhat historical in nature, we focus on the initial stage
because this period is largely ignored in existing studies. Fragmentary data and
chaotic economic conditions made systematic analysis problematic (Djankov and
Murrell, 2002; Iwasaki, 2007). To date, only two studies have analyzed Russias initial
stage of transition (Brown and Earle, 2001; Sabirianova et al., 2005); no study focuses
on industry differences. By documenting efficiency patterns within and across
industries between 1992 and 1995, this study provides a baseline for examining the
impact of the transition on firm performance, a feature stressed in studies conducted in
other transition economies (Brada et al., 1997; Kemme and Neufeld, 1991; Konings and
Repkin, 1997). More generally, this study takes another step towards better
understanding the consequences of the Soviet development model.
Second, conducting the analysis by industry allows us the opportunity to examine
the differential impact caused by the transformation. For example, during the initial
stage of Russias transition, industries experienced different rates of inflation (see
Table I), and output reduction. According to the national statistical agency,
Goskomstat (1996), output in 1995 was only 80 percent of the 1990 level in power, 62
percent in fuel, 52 percent in food processing, 40 percent in machine building, and 19
percent in light industry. Do these industry output changes correspond to industry
efficiency improvements?
Third, analyzing industry differences in 1992 and 1995 enables us to assess whether
particular firm characteristics have the same influence on efficiency across sectors and
over time. Such information helps to fill the knowledge gap associated with how
JES
Industry 1992 1993 1994 1995
38,4
Heavy industry
Power 5.510 1.360 330 300
Fuel 10.010 560 290 280
Ferrous metallurgy 3.620 1.190 340 290
432 Machine building. metal working 2.720 1.050 330 280
Chemicals 3.890 950 360 270
Average heavy industry 5.150 1.022 330 284
Light industry
Light industry 1.260 780 340 260
Food processing 2.730 1.070 310 260
Consumer/miscellaneous N/A N/A N/A N/A
Average light industry 1.995 9.25 325 260
Other industry
Printing N/A N/A N/A N/A
Table I. Wood 2.020 990 370 270
Price change by industry, Construction materials 2.810 1.250 310 270
1992-1995 (percent) Average other industry 2.415 1.120 340 270

Russian firms responded to the chaotic economic environment, and addresses a more
general issue of whether particular locations, such as the capital city, are favored in the
development and/or transition process.
Our analysis proceeds as follows: section 2 highlights the potential effects of the
Soviet development legacy on firm efficiency during the initial stage of Russias
transition and specifies the hypotheses we will be testing. Section 3 describes the data
used in our analysis. The methodology used to estimate technical efficiency is
presented in section 4. Section 5 discusses our results. We find that firms in
low-priority sectors exhibited higher efficiency in 1992 than firms in high-priority
sectors. By 1995, efficiency differences diminish. Between 1992 and 1995, efficiency
gains were relatively higher in industries that experienced the largest percentage
output decline. Non-state ownership tends to improve efficiency, but the ownership
effect varies by industry and over time. We reject the hypothesis that export experience
increases efficiency, and this result is especially strong in 1995. Location in Moscow
proved to be a positive factor, and the benefit grew over time. Section 6 offers
concluding remarks.

2. Soviet development legacy and the technical efficiency of Russian firms

Five features of the Soviet development strategy likely influenced technical efficiency
in Russias transition environment:
(1) a priority to heavy industry, reflected in the relentless increase in capital
regardless of cost and lack of economic benefits (Amann et al., 1977; Dyker,
1983; Leary and Thornton, 1989);
(2) a commitment to job rights, which contributed to excessive or overfull
employment in all sectors (Granick, 1987);
(3) a relatively small share of non-state-owned firms in 1992 (Radygin, 2003);
 (4) prohibition until the late 1980s of firms participating in global markets Analyzing the
(Lawrence and Vlachoutsicos,1990); and efficiency of
(5) the disproportionate concentration of resources in Moscow (Bahry, 1987; Russian firms
Thornton and Nagy, 2006).

2.1 Priority to heavy industry

Soviet planners implemented different investment policies across industries, with 433
heavy industry enjoying abundant allocations and light industry often under-provided
(Dyker, 1983). Planner preferences to maximize growth and managerial strategies to
maximize bonuses combined to result in high capital intensity in heavy industry in
comparison to light industry, and in comparison to similar firms in market economies
(Amann and Cooper, 1982; Berliner, 1976).
Soviet investment policies, and the absence of an established mechanism for selling
capital equipment, likely influenced firm efficiency in the initial stage of Russias
transition. If firms in high-priority sectors had abundant capital and thus were not
obliged to use it effectively, even though its value was included in the firms
performance indicators (Malle, 1987), then these firms will likely exhibit lower average
efficiency in 1992. Such conditions would also likely contribute to greater variance in
efficiency between high and low priority sectors at the beginning of Russias transition.
We investigate both propositions.
If efficiency differences emerge between 1992 and 1995, we speculate that they will be
linked to the degree of monopoly power in the industry. We measure where monopoly
power by the share of firms in the industry that are identified by Russian authorities as
monopolist producers[2]. That is, following Earle and Estrin (2003), we expect higher
average efficiency in industries with lower monopoly power (greater competition). Since
Goskomstat (1996) reports a higher percentage of monopolists in (Soviet) high priority
sectors (i.e. 11 percent in ferrous metallurgy, 9.5 percent in chemicals, 5.2 percent in
machine building, and 2.6 percent in fuel) compared to low-priority sectors (i.e. 0.4 percent
in wood, 0.3 percent in construction materials, 0.2 percent in food processing, and 0.1
percent in light industry in 1995), we hypothesize that the pattern of technical efficiency
between priority and non-priority sectors will remain the same between 1992 and 1995.

2.2 Commitment to job rights

In the Soviet economy, able-bodied adults were obliged to work for state-owned
organizations, which in turn provided housing, health care, child care, special access to
goods, and the like (Clarke, 1996). Moreover, managers were effectively unable to
release surplus workers. Indeed, the combination of parasite laws and job rights
contributed to excessive or overfull employment in the Soviet economy (Granick,
1987; Gregory, 1987). The negative consequences for efficiency of employing surplus
workers is described in detail by Mostafa (2007).
Numerous studies show that between 1992 and 1995 managers did not release
workers in accordance with reported output declines, but rather kept them on the
books, frequently in an unpaid capacity (Desai and Idson, 2000; Linz, 2000; Standing,
1996). Evidence suggests that this practice was widespread rather than sector- or
industry-specific (Clarke, 1999; Commander and Coricelli, 1995; Linz, 1995 1998).
Consequently, we continue to expect little change in industry patterns of technical
efficiency between 1992 and 1995.
JES 2.3 Ownership and efficiency
38,4 Despite the legalization of quasi-private firms in the late-1980s, Goskomstat data
indicate that 85-95 percent of the manufacturing firms in priority sectors and 80-85
percent of those in non-priority sectors were state-owned in 1992 (Goskomstat, 1996).
Non-state-owned firms were ineligible for state subsidies and obliged to compete for
physical and financial inputs allocated initially to the planned economy. Thus they
434 emerged where demand conditions and profit potential were most favorable (Jones and
Moskoff, 1991; Lawrence and Vlachoutsicos, 1990); especially in sectors with minimal
initial capital outlay requirements. Subject to confiscatory tax rates and lack of popular
support in the Soviet economy, we speculate that non-state-owned firms survived, in
part, by adopting best-practice production methods. Consequently, we expect that
non-state-owned firms, regardless of sector, will exhibit higher technical efficiency
in 1992.
Russias mass privatization program began in June 1992 and quickly removed
ownership from state control. By the end of 1994, shares in more than 15,000
manufacturing firms were transferred from state to private hands (Brainerd, 2002;
Filatotchev et al., 1999). These privatized firms accounted for over three-quarters of
total industrial employment (Russian Economic Trends, 1995, p. 40). However, the
incentive of privatized firms to operate more efficiently was undermined by several
factors. First, because the privatization program basically transferred ownership to
existing employees, and, in the vast majority of firms, little turnover in top-level
management occurred before 1995 (Linz, 1996), privatized firms had little incentive
to reduce workforce size, especially prior to the removal of the excess wage tax in
1996 (Clarke, 1998; Linz, 1998). Second, subsidies to loss-making firms continued
unabated through 1995 (Clarke, 1996), precluding the need to reduce workforce size
or otherwise adjust production methods. Third, monopoly power, especially when
measured as exhibiting significant regional influence, dominated Russias
manufacturing environment (Starodubrovskaya, 1994; Yakovlev, 1994). Finally,
the ability of privatized firms to adopt industry best-practice methods was
undermined by the lack of financing options available during the initial stage of
Russias transition, hampering efforts to renovate out-dated capital (Linz and
Krueger, 1998).
Given mixed results reported in studies that examine the relationship between
ownership and efficiency during the initial stage of Russias transition Sabirianova
et al. (2005) find no impact of private ownership on efficiency; Brown and Earle (2001)
find a significant positive effect we propose to test the hypothesis that state-owned
firms in both 1992 and 1995 exhibit lower average technical efficiency than
non-state-owned firms[3].

2.4 Export experience

The few firms with export experience when Russias transition began in 1992 were
thought to have an advantage (Lawrence and Vlachoutsicos, 1990). They had trading
partners, access to information about potential clients and market conditions, and
established hard currency accounts in both domestic and foreign banks. Following the
logic presented by Yeung and Mok (2008), we hypothesize that firms with export
experience in 1992 or 1995 will be more likely to exhibit higher efficiency than
non-exporters. They argue that because firms self-select into the export market, where
conditions are more competitive, these firms will likely be more productive, regardless Analyzing the
of ownership structure. This expectation is in fact supported among Russian firms efficiency of
during a later stage of the transition process (Wilhelmsson and Kozlov, 2007).
Russian firms
2.5 Priority to Moscow
Throughout the Soviet period, Moscow enjoyed a high concentration of economic and
human resources in comparison to all other regions (Bahry, 1987; Thornton and Nagy, 435
2006). In 1992, Moscow remained the financial, transportation, and communications
center of Russias economy. Not only the showcase of Russia, it provided access to
political and economic officials, likely aiding local managers in acquiring highest
quality resources or equipment. As one of the most desirable places to live, local
managers were also able to attract highly skilled workers. We therefore hypothesize
that in 1992 Moscow firms will exhibit higher technical efficiency that firms located
elsewhere.
During the transition from plan to market, Moscow firms not only retained local
advantage in terms of access to officials, financial and physical resources, skilled labor,
and transportation and communication networks, but also likely felt more competition,
more quickly, from global markets than did firms in the provinces. Since Earle and
Estrin (2003) found a positive relationship between competition and efficiency, we test
the proposition that location in Moscow continued to have a positive effect on
efficiency in 1995.

3. Characteristics of civilian manufacturing firms in Russias Central

region
We use data from business directories published by a private company which compiled
firm-level data collected by Goskomstat (Business Information Agency, 1993;
Biznes-Karta, 1995). The companys objective was to report basic location, production,
and employment information for civilian manufacturing firms in Russia to both
domestic and foreign clients. Previously such information had been considered a state
secret and thus unavailable. While the directories provide neither financial nor input
utilization information, they do provide information about industry classification,
output, capital, labor, ownership, location, and export experience for the civilian
manufacturing firms in Russias Central region.
Registration numbers allow us to match firms in the 1992 and 1995 directories, but
we elect not to utilize panel data in this analysis. First, near-hyper-inflationary
conditions and changes in capital valuation methods between 1992 and 1995 make it
impossible to adjust value differences in output and capital accurately (Izyumov and
Vahaly, 2008; Linz, 1994; Radygin, 2003). Second, many firms divided into multiple
units during privatization. Constructing a panel among the subset of firms that did not
divide would considerably reduce sample size, and since firms tended to divide
according to profit centers, focusing only on firms that did not divide would bias the
results. Third, some firms changed industry classification. Using panel data would
require that these firms be dropped from the analysis[4]. Fourth, while industry
technological level likely did not change during this chaotic three-year period, capital
and labor utilization likely changed in ways that would not be captured by simply
including a time dummy. Consequently, we conduct our industry efficiency analysis
separately by year.
JES 3.1 Sample description
38,4 We group firms from the 11 industries reported in the directories into three categories:
(1) heavy industry (power, fuel, ferrous metallurgy, machine building and metal
working, chemicals), which received high priority in the Soviet economy;
(2) light industry (food processing, light industry, consumer/miscellaneous), which
received low priority; and
436
(3) other industry (printing, wood, construction materials).

Firms employing fewer than ten workers and those with implausibly low values for
output or capital were dropped from the samples, leaving us with 3,896 firms in 1992
and 3,186 firms in 1995.
The speed and scope of ownership transfer during Russias privatization program is
documented in Figure 1: the proportion of state-owned firms fell from 85-95 percent in
1992 to 20-30 percent by 1995. Printing and fuel retain the highest share of
state-ownership in 1995. We note that, among the firms in our sample, the likelihood
that a firm is privatized by 1995 is affected by firm size in 1992, but not by the firms
efficiency score in 1992.
Output is measured as the current ruble value of the firms volume of production.
Figure 2 reports output produced by state-owned firms as a percentage of private
firms output in 1992 and 1995. As seen in Figure 2, the share of state production in
1992 exceeds 50 percent of private firms production in all but chemicals; state
production share exceeds 100 percent in power, ferrous metallurgy, machine building,
light industry and printing. By 1995, the share of state production is 50 percent (or less)
of private production in power, fuel, machine building, chemicals, light, wood, and
construction materials. We note that food processing exhibits a substantial increase in
state production relative to private production between 1992 and 1995.

Figure 1.
State ownership by
industry, 1992 and 1995
(percent)
 Analyzing the
efficiency of
Russian firms

437

Figure 2.
Output of state-owned
firms as a percentage of
private firms, 1992 and
1995

Labor is measured by the number of employees reported to local authorities by each

firm. Firms report full-time equivalents[5], and we assume that any reporting bias,
such as that associated with the excess wage tax or continued commitment to the
institution of job rights, for example, would be the same across industries.
Figure 3 illustrates, by industry, mean workforce size among state-owned firms as a
percentage of their non-state-owned counterparts. As seen in Figure 3, state-owned firms
in 1992 tended to employ significantly more workers. Among the firms in our sample,

Figure 3.
Workforce of state-owned
firms as a percentage of
private firms, 1992 and
1995
JES heavy industry firms tended to be much larger, on average, than firms in light industry
38,4 in 1992. This remains generally so in 1995, despite rather substantial employment
reductions in ferrous metallurgy (33 percent), chemicals (29 percent) and power (25
percent). Smaller workforce size stems, in part, from new labor codes adopted in 1992
that permitted firms to release redundant workers. However, the excess wage tax in
effect until 1996 discouraged workforce downsizing, instead causing firms to pursue a
438 variety of non-payment options (Desai and Idson, 2000; Standing, 1996).
Capital, reported as the residual cost of capital assets, is taken to mean the current
book value of the firms assets; that is, the initial cost of capital adjusted for
depreciation and inflation. We note that the initial cost of capital was determined by
Soviet planners, not by market forces. New capital valuation guidelines involving
arbitrary adjustments to existing capital values were established by Goskomstat in
1992 to facilitate the privatization process. Firms targeted for privatization were
required to use the revised capital asset values in all documents relating to the
privatization process[6]. Thus capital values reported in the directories are unlikely to
reflect quality differences. Moreover, given the lack of market-oriented institutions in
place prior to 1995 and the fact that depreciation rates were calculated on a
straight-line basis between 1992 and 1995, capital valuation biases inherited from the
Soviet economy are likely to remain during this initial stage of Russias transition. For
additional discussion of the problems associated with measuring capital and
evaluating its contribution to output, see Izyumov and Vahaly (2008).
Figure 4 illustrates how quickly Russias privatization program transferred state
assets to non-state hands. The capital value of state-owned firms as a percent of
non-state firms is dramatically higher in 1992 compared to 1995. Table II documents
capital intensity among the firms in our sample. Average capital values are at least
three times higher among firms in the heavy industry category as compared to the

Figure 4.
Capital value of
state-owned firms as a
percentage of private
firms, 1992 and 1995
 State Non-state
Depreciation Depreciation
Average K K/L K/Q (percent) n Average K K/L K/Q (percent) n
1992 (rubles, thousands)
Heavy industry
Power 145,700 258 204 51.5 60 141,227 41 0.2 32.5 2
Fuel 20,186 21 1.8 49.0 107 20,186 0
Ferrous metallurgy 39,823 20 2.7 38.6 39 36,632 401 40.7 36.3 6
Machine building, metal working 30,287 15 1.8 40.4 630 27,071 55 2 40.6 113
Chemicals 29,985 30 1.7 48.9 120 28,618 13 0.1 37.1 12
Average heavy industry 36,817 33 14.5 43.1 956 33,477 67 4 40.0 133
Light industry
Light industry 11,374 12 0.5 38.4 480 10,336 17 0.6 38.7 99
Food processing 3,507 15 0.3 37.1 793 3,562 13 0.2 34.6 114
Consumer/miscellaneous 4.053 9 0.2 42.7 161 3,462 6 0.2 38.5 56
Average light industry 5,862 13 0.4 38.1 1,434 5,576 13 0.3 36.7 269
Other industry
Printing 900 5 0.5 48.9 218 902 9 0.5 57.3 4
Wood 5,212 15 0.6 40.8 444 5,372 15 0.5 38.3 51
Construction materials 8,202 21 0.7 40.6 303 7,823 19 1.9 41.5 84
Average other industry 5,332 14 0.6 42.6 965 5,468 17 1.3 40.7 139

1995 (rubles, thousands)

Heavy industry
Power 3,336 3 0.3 49.0 16 9,361 13 40.8 40.7 76
Fuel 45,648 200 73.8 47.2 34 1,369,127 2.693 31.9 54.3 28
Ferrous metallurgy 54,151 52 10.6 45.2 52 27,910 23 11.6 44.2 198
Machine building, metal working 9,482 31 17.3 42.7 119 415,481 346 338.9 42.9 347
Chemicals 9.104 25 30.9 46.2 26 101.676 138 26.0 47.1 125
Average heavy industry 22,921 56 24.0 44.7 247 296,489 283 164.3 44.3 774
Light industry
Light industry 4,004 13 14.8 41.7 91 51,696 78 19.1 44.5 426
Food processing 19.558 12 1.5 43.8 125 23,512 83 321.6 35.9 547
Consumer/miscellaneous 3,389 4 0.8 51.5 21 28,274 84 27.9 42.3 81
Average light industry 12,153 11.7 6.5 43.6 237 35,175 81 176.7 39.7 1,054
Other industry
Printing 544 9 10.4 47.4 114 2,079 62 68.4 34.7 15
Wood 8,509 27 17.4 44.6 181 22,682 104 32.1 44.3 293
Construction materials 6,231 22 8.5 44.7 40 16,783 215 275.6 45.6 231
Average other industry 5,527 21 13.9 45.5 335 17,812 151 223.2 44.6 539
Analyzing the

industry and ownership,

Capital intensity by
Russian firms

1992 and 1995

439

Table II.
efficiency of
JES light and other industry categories in 1992, regardless of ownership structure. Capital
intensity, measured in terms of labor and output, appears higher in heavy industry,
38,4 although no clear pattern by ownership structure emerges. In 1995, the distinction
remains between heavy and light industry in terms of average capital value and
significant ownership differences are now apparent. Higher capital intensity is evident
among the non-state-owned firms, regardless of sector.
440 The directories provide information about the volume of a firms exports by product
type, but not the value or the destination country. Few firms in the Central region had
export experience in 1992: 167 in heavy industry, 76 in light industry, and 57 in other
industry. Fewer still reported export experience in 1995: 31 in heavy industry, 26 in
light industry, and 20 in other industry. We note that in both years, about 90 percent of
the exporters were state-owned. We construct a binary variable equal to 1 for export
experience, because it was impossible to calculate the firms volume of exports
(measured in physical units) as a percentage of the firms total output (measured in
current rubles).
As for location in Moscow, 581 firms in Moscow (city oblast) reported the requisite
information in 1992, and 444 firms reported the necessary information in 1995.

4. Using stochastic frontier approach to estimate technical efficiency

Did the Soviet development strategy of according high priority to firms in heavy
industry give these firms an advantage during the first stage of Russias transition?
We employ the stochastic frontier approach (SFA) developed independently by Aigner
et al. (1977) and Meeusen and van den Broeck (1977) to estimate technical efficiency by
industry in both priority and non-priority sectors in 1992 and 1995[7]. Given the
turbulence of the period considered, SFA dominates the alternative method data
envelopment analysis (DEA) because SFA allows analysts to distinguish random
shocks that affect the production frontier (machinery breakdown, new policies
affecting access to or utilization of inputs, and so forth) from factors over which the
firm has some control (workforce size, skill and effort; capital utilization, for
example)[8]. We estimate the production function separately for each year because of
significant changes in the sample composition between 1992 and 1995, and because
firms likely changed their output mix (production assortment) during this period (Linz
and Krueger, 1998).
The production frontier is specified as:
ln Qi f b; X i ni 2 mi ; 1
with ni~N 0; s2n and mi~N mi ; s2m , where Qi is the output of the firm, f(.) is the
production function, Xi is the vector of inputs, and b is the vector of parameters to be
estimated. Following the literature, ni and mi are assumed to be identically and
independently distributed and uncorrelated with Xi. Stochastic shocks to the firms
production frontier are measured by ni. mi is the non-negative parameter that measures
inefficiency (hence the ). When a firm is fully efficient (on the frontier), mi equals 0.
Technical efficiency of firm i, conceptually the ratio of actual output to industry
best-practice output, can be presented as:
TE i e2mi : 2
4.1 Identifying firms on the production frontier Analyzing the
How does the distribution of firms on the production frontier vary between priority and efficiency of
non-priority sectors? Let sm and sn be the standard errors of inefficiency and random
disturbance terms (from equation (1)), respectively. We define g as the ratio of standard Russian firms
error of the inefficiency term to the total standard error:

gi sm =sm sn : 3 441
Since g captures that part of total variance caused by inefficiency, if g is not different
from zero, it implies two possibilities:
(1) nearly all firms in the industry are on the frontier (there is no significant
industry inefficiency); or
(2) the noise from the two-sided error is so high that it is not possible to estimate
the inefficiency term.

If g is significantly different from 0, we conclude that there is significant industry

inefficiency. Thus we use g to establish the existence of technical inefficiency among
firms in priority and non-priority sectors in 1992 and 1995.

4.2 Factors influencing efficiency

We follow the method of Battese and Coelli (1992, 1995) to estimate the effect of
firm-specific characteristics on technical efficiency by simultaneously estimating two
equations:

ln Qi f b; X i ni 2 mi ; 1

m i dZ i w i ; 4

where Zi represents the firm-specific factors that affect efficiency and wi is N 0; s2m
truncated from the left at 2 dZi. This method assumes independent but not identical
distribution of m.

4.3 Regression model

Following Battese and Coelli (1992, 1995), and using the FRONTIER 4.1 software
developed by Coelli (1994), we estimate a frontier Cobb-Douglas production function
for each industry[9]:

ln Qi a b1 ln Li b2 ln K i ni 2 mi ; 5

where Q is output, L is labor, K is capital, and ni and mi are the two-sided disturbance
term and inefficiency measure, respectively. Simultaneously with equation (5), we
estimate, using dummy variables, the effects of ownership (non 2 state 1), export
experience (export 1) and location (Moscow 1) on inefficiency using the following:

mi d0 d1 ownership d2 export d3 Moscow wi : 6

Our results from the stochastic frontier estimation are provided in section 5.
JES 5. Empirical results
38,4 First, we examine the incidence of technical inefficiency in 1992 and 1995 in priority
and non-priority sectors by testing whether g (equation (3)) is different from 0. Then,
using estimated efficiency scores (equation (2)), we summarize, by industry, the mean
efficiency scores, as well as the variance of the efficiency scores, for 1992 and 1995.
Finally, for each industry, we assess the effect on efficiency of ownership, export
442 experience and location in Moscow.

5.1 Frontier estimation results

SFA results presented in Table III document pronounced industry differences in
inefficiency in both 1992 and 1995. We note that in 1992, g is positive, large, and
significant among firms in power, ferrous metallurgy, machine building, and
chemicals industries receiving the highest priority in the Soviet economy. Only in
fuels is g not significant. Inefficiency is less widespread in industries receiving low
priority in the Soviet economy. That is, g is large, positive, and significant among light
industry firms, and among firms in construction materials, but not in the other low
priority industries. These results conform with our speculation that firms accorded
high priority in the Soviet economy received but may not have effectively used the
abundant capital allocated to them.
The industry pattern of inefficiency changes by 1995, although not completely
conforming with our speculation that the incidence of inefficiency will be less in
industries with low monopoly power (relatively more competition). We find that
inefficiency is less widespread in the (former) high-priority sectors by 1995. More
specifically, while g remains large, positive, and significant in power and ferrous
metallurgy, industries characterized by the highest percentage of monopolists in 1995,
g is quite small in chemicals. Inefficiency is more widespread in 1995 among firms in
(former) low priority sectors: light industry, food processing, consumer/miscellaneous,
and construction materials, industries characterized by limited monopoly power.
While these results underscore the importance of analyzing efficiency by industry in
Russias transition economy, they also suggest that thinking more broadly about what
might constitute monopoly power in transition (or developing) economies might be
warranted. Industry differences in inefficiency are pronounced in 1992, and the
differences that emerge by 1995 suggest that market forces were not dominating the
production decisions of manufacturing firms in Russias Central region. Given the
limited time for adjustment and the nature and scope of the Soviet legacy in Russia,
these results appear quite plausible.

5.2 Average efficiency

We hypothesized that in 1992 firms in priority industries would be less likely than
firms in non-priority industries to operate close to the industry production frontier; that
is, firms in heavy industry would exhibit lower efficiency and higher variance than
firms in light industry. Moreover, given Russias privatization program, limited access
by firms to financial resources, and little management turnover prior to 1995, we
hypothesized that the pattern of inefficiency differences between firms in priority and
non-priority sectors would be sustained between 1992 and 1995. We note that because
the privatization program caused many firms to split into multiple units, and other
firms to concentrate production on items that caused their firm to be put into a new
 Heavy industry Light industry Other industry
Ferrous Machine Light Food Construction
Variable Power Fuel metallurgy building Chemicals industry processing Miscellaneous Printing Wood materials

1992
Constant 4.06 * * * 2.40 * * * 4.66 * * * 3.81 * * * 5.35 * * * 2.55 * * * 4.02 * * * 3.19 * * * 1.68 * * * 2.49 * 2.53 * * *
K 0.10 0.26 * * * 0.02 0.16 * * * 0.19 * * 0.10 * * * 0.22 * * * 0.27 * * * 0.07 0.08 * 0.23 * * *
L 1.03 * * * 0.72 * * * 0.98 * * * 0.80 * * * 0.68 * * * 1.25 * * * 0.84 * * * 0.72 * * * 1.14 * * * 1.03 * 0.86 * * *
s2 56.34 0.86 * * * 3.11 * * * 1.60 * * * 4.34 * * 2.91 * * * 0.90 * * * 603 * * * 0.38 * * * 0.67 * * * 0.54 * * *
y 0.99 * * * 0.04 0.77 * * * 0.64 * * * 0.74 * * * 0.79 * * * 0.01 7.0E-07 0.01 0.0001 0.01 * * *
ln l 2 137.48 2 142.21 2 71.65 2 1,039.62 2 224.75 2 758.65 2 1,244.43 2321.18 2 207.31 2 617.06 2 475.07
Number
of firms 62 107 45 743 132 579 907 217 222 495 387
1995
Constant 2.52 2 0.77 0.60 1.28 * * * 1.09 * * 2 0.19 2.11 * * * 0.63 0.01 2 0.32 0.12
K 0.38 0.27 * * * 0.09 * * * 0.08 * * * 0.12 * * * 0.13 * * * 0.06 * * * 0.19 * * * 0.002 0.09 * * * 0.09 * * *
L 0.46 * * 0.72 * * * 1.03 * * * 0.94 * * * 0.86 * * * 1.08 * * * 1.03 * * * 0.81 * * * 1.15 * * * 0.91 * * * 1.13 * * *
2
s 11.20 * * * 0.80 * * * 2.21 * * * 1.32 * * * 1.76 * * * 16.64 * * 8.76 * * * 31.32 * 0.83 * * * 0.82 * * * 17.47 * *
y 0.99 * * * 0.09 0.60 * * * 0.002 0.0004 * * * 0.96 * * * 0.93 * * * 0.98 * * * 1.00E-05 4.00E-06 0.97 * * *
ln l 2 202.50 81.59 2 374.12 2 774.89 2 261.79 2 736.89 2 990.29 2160.83 187.76 2 684.59 2 392.92
Number
of firms 92 62 250 466 151 517 672 102 128 474 271

Notes: *Significant at 10 percent; * *significant at 5 percent; * * *significant at 1 percent

Analyzing the

Russian firms

and 1995
estimation result, 1992
Stochastic frontier
Table III.
443
efficiency of
JES industry category, it is not possible to make precise comparisons by industry over
38,4 time. Consequently, we focus on the average efficiency pattern between priority and
non-priority sectors.
Table IV reports average efficiency by industry. These results indicate substantial
efficiency gains were possible among firms in the power industry, where the efficiency
score in 1992 was 0.35. Similarly, efficiency gains were possible in other (non-fuel) sectors:
444 in chemicals, for example, the average efficiency score was 0.57, and in machine building,
0.66. Indeed, industry efficiency scores are substantially lower in 1992, on average, among
firms in heavy industry (0.58) in comparison to firms in light industry (0.83) and other
industry (0.90), which supports our first hypothesis. Moreover, the variance is at least
twice as high among industries in the priority sector (0.17), in comparison with
non-priority sectors in 1992 (0.08, 0.06), which suggests that heavy industry firms
inherited more capital and labor utilization options than firms in light and other industry.
By 1995, the distinction in average efficiency scores between heavy industry (0.59)
and light industry (0.62) has disappeared, as has the difference in variance (0.17
compared to 0.15). Thus, our second hypothesis i.e. no change in the efficiency
pattern between priority and non-priority sectors is not supported. Instead, we find
that fewer firms in light industry exhibited industry best-practice production in 1995,
despite the relatively high degree of reported competition in all industries in this sector.
As seen in Table IV, efficiency scores in light industry range from 0.58 to 0.65. We note
that mean workforce size in the non-priority sector, particularly in food processing, did
not decline as much by 1995 as in the priority sector where significant reductions
occurred in several industries.

5.3 Factors influencing efficiency

Table V reports the effect of ownership, export experience, and location in Moscow on
firm inefficiency in 1992 and 1995.

1992 1995 Change (percent)

Industry Mean TE Var TE Mean TE Var TE Mean TE Var TE

Heavy industry
Power 0.35 0.24 0.15 0.20 2133.33 2 20.00
Fuel 0.72 0.11 0.67 0.15 27.46 26.67
Ferrous metallurgy 0.61 0.21 0.62 0.13 1.61 2 61.54
Machine building, metal working 0.66 0.11 0.57 0.27 215.79 59.26
Chemicals 0.57 0.16 0.96 0.10 40.63 2 60.00
Average heavy industry 0.58 0.17 0.59 0.17 2.02 2.35
Light industry
Light industry 0.72 0.08 0.65 0.14 29.72 75.00
Food processing 0.84 0.05 0.63 0.14 225.00 180.00
Consumer/miscellaneous 0.94 0.10 0.58 0.16 238.30 60.00
Average light industry 0.83 0.08 0.62 0.15 95.75 47.73
Other industry
Table IV. Printing 0.97 0.03 0.99 0.08 2.06 166.67
Mean technical efficiency Wood 0.96 0.02 1.00 0.00 4.17 2 100.00
by year and industry, Construction materials 0.77 0.14 0.66 0.12 214.29 2 14.29
1992 and 1995 Average other industry 0.90 0.06 0.88 0.07 97.33 5.00
 Heavy industry Light industry Other industry
Ferrous Machine Light Construction
Variable Power Fuel metallurgy building Chemicals industry Food Miscellaneous Printing Wood materials

1992
Constant 223.5 0.4 2 2.8 2 1.2 * * 2 1.5 2 5.3 * 0.15 0.1 2 0.1 0.1 0.39 * * *
Export N/A 2 0.1 210 2 1.4 * * 2 5.5 1.2 20.9 0.6 0.3 2 0.02 0.1
Moscow 222.7 2 0.7 3.4 * 2 0.4 2 0.9 1.6 2 0.1 20.7 * * * 0.1 20.4 * * * 21 * * *
Non-state 238 N/A 3.6 2 1.4 * 2 6.9 2 1.4 0.2 * 2 0.2 2 0.4 2 0.4 * * * 20.3 * * *
Joint venture N/A N/A 2 1.9 2 6.3 * * N/A 2 8.8 N/A 0.7 N/A N/A 1***
ln l 2 118.90 2 141.13 2 66.49 21,019.2 2 218.34 2 741.89 2 1,240.82 2311.29 2 207.07 2 604.12 2423.11
LR 37.18 2.17 10.31 40.83 12.82 33.52 7.23 19.78 0.5 25.90 103.91
1995
Constant 20.8 0.6 2 0.9 1.1 * * * 0.4 2 19 * 2 9.9 * * * 2 35.6 2 0.1 2 0.5 233.4 * *
Export N/A N/A 0.5 0.6 2 0.3 10.2 28.1 * * * 7.1 * * N/A 20.2 8.5 * *
Moscow 6.2 * * * 2 2.2 2 8.3 2 1.2 * * * 2 0.6 * * 4.4 * 2 11.1 * * * 2 6.7 * * * 2 1.3 * * * 20.2 * * * 0.1
Non-state 0.4 2 0.6 2 0.3 2 2.9 2 0.6 * 2 13.8 * * 2 2.5 * * * 2 3.2 * * 2 0.001 20.4 * * * 3.1
Joint venture N/A N/A 2 8.2 2 1.8 * * * N/A N/A N/A N/A 4.4 * * * 21.9 N/A
ln l 2 171.66 2 79.68 2 369.14 2735.81 2252.41 2 946.22 2 151.00 2170.78 2 624.43 2371.46
LR 61.70 3.81 9.95 78.15 18.76 55.70 88.14 19.67 33.98 120.32 42.93
Notes: Coefficients presented come from simultaneous estimation of equations (5) and (6). Logarithmic likelihood ratio tests the hypothesis that coefficients s 2 versus ln l in
equation (6) are equal to zero. The ratio has a mixed x 2 distribution. * ; * * and * * * significantly different from zero at the 10 percent, 5 percent and 1 percent significance
levels, respectively

Estimated efficiency
Analyzing the

Russian firms

effects, 1992 and 1995

Table V.
445
efficiency of
JES 5.3.1 Ownership. As seen in the top panel of Table V, in 1992, non-state ownership
38,4 reduces inefficiency in machine building, wood, and construction materials. In food
processing, non-state ownership has the opposite effect. We include a dummy variable
equal to 1 for joint ventures because joint ventures typically had access to modern
capital and were less influenced by the Soviet legacy than privatized domestic firms. In
machine building, joint ventures substantially reduce inefficiency in 1992, but in
446 construction materials we observe the opposite effect. By 1995, non-state ownership
has a significant positive influence on reducing inefficiency among firms in light
industry as well as firms in chemicals and wood industries. Joint ventures in machine
building substantially reduce inefficiency; the effect is opposite among firms in
printing, where only two joint ventures were in operation in 1995 in an otherwise
state-owned environment.
These results support the need to consider industry differences when evaluating the
influence of ownership on efficiency. Our results indicate that private ownership is
associated with higher efficiency in some industries, but not others, which suggests
that privatization, per se, does not cause firms to exhibit or adopt best-practice
production method. This result may be driven by the nature of Russias privatization
program, which initially simply transferred ownership from the state to the firms
employees. Not until after 1995 was there any substantial change in management or
ownership (outsiders, blockholders). Joint venture results are mixed, which we
attribute to the small number of observations.
5.3.2 Export experience. Export experience had a positive effect on efficiency in
machine building in 1992 (Table V, top panel), and in food processing in 1995 (bottom
panel), but the opposite result was obtained in the construction materials and
consumer/miscellaneous industries. These mixed results are curious because the
incentive to misreport output would be the same for all firms, and there is nothing to
suggest that firms in some industries were scrutinized by tax or other authorities more
stringently than firms in other industries during this chaotic time. Thus we would
expect a positive sign for exports, but could explain a negative sign if firms were
under-reporting output for black market sale. Additional research is warranted on the
link between exports and efficiency.
5.3.3 Location in Moscow. Location in Moscow had a positive effect on efficiency in
1992, although the result was only statistically significant among firms in the
construction materials, wood, and consumer/miscellaneous industries (Table V, top
panel). The opposite effect was obtained for firms in ferrous metallurgy. Location in
Moscow had a positive effect on efficiency in more industries in 1995 (Table V, bottom
panel), which may be attributed to Moscow firms facing more competition and/or
access to higher quality labor and capital inputs. It is clearly the case that location in
Moscow is an important part of explaining firm performance during the initial stage of
Russias transition to a market-oriented economy.

6. Summary and conclusions

At the beginning of Russias transition, little was known about the level and variation
in technical efficiency inherited from the former Soviet economy. Moreover, efforts to
evaluate the impact of the transition on firm performance typically ignored the period
1992-1995, when economic conditions were most chaotic and the paucity of firm-level
data was most acute. Consequently, no systematic analysis of efficiency differences
between firms in priority and non-priority sectors in the former Soviet economy has Analyzing the
been conducted, and little attention has focused on factors explaining industry efficiency of
variation in the incidence of best-practice production methods. We address this
knowledge gap using firm-level data collected in 1992 and 1995 from nearly 3,900 Russian firms
civilian manufacturing firms in Russias Central region. We focus, first, on whether
firms in industries that received high priority in the Soviet economy were more likely
to exhibit best-practice production methods during the initial stage of Russias 447
transition and, second, on the relative importance of ownership, export experience, and
location in Moscow in explaining the variation in technical efficiency.
We employ the stochastic frontier approach to estimate the technical efficiency of
Russian firms in both priority and non-priority sectors, and follow the method of
Battese and Coelli (1992, 1995) to estimate the effect of firm-specific characteristics on
technical efficiency. We find pronounced industry differences. Our results indicate
widespread inefficiency in 1992 in industries that received high priority in the Soviet
economy, with inefficiency less widespread in industries receiving low priority. By
1995, differences between former priority and non-priority sectors were less
pronounced, but the industry pattern of inefficiency suggests a rather limited role
for market forces.
Firms in (former) high-priority sectors exhibited lower average efficiency scores and
higher variance in 1992 in comparison to firms in low-priority sectors. By 1995, the
distinction in average efficiency scores between firms in (former) priority and
non-priority sectors has disappeared, as has the difference in variance. We also note
that industries which experienced the largest percentage output decline by 1995 food
processing, machine building, light industry exhibited relatively high efficiency
gains.
Our results indicate that privatization, per se, does not cause firms to adopt industry
best-practice production methods. Private ownership is associated with higher
efficiency in some industries but not others. Contrary to our expectation, export
experience is not linked to higher efficiency, but location in Moscow does have a
positive effect, and this effect is observed in more industries in 1995.
Generally, our results underscore the magnitude of structural dislocation caused by
planners preferences. Priority sectors did not exhibit greater efficiency. Indeed, the
Soviet legacy provided serious obstacles to production adjustments. Whether this
result holds true more generally, for other transition or developing economies, remains
a question. It is clear that many firms included in this analysis adjusted their
operations, albeit rather marginally, in a manner consistent with the emergence of a
market-oriented economy. Given the severity of the transitions impact across all
sectors, and the lack of resources and institutions to support their adjustments, these
results attest to the resourcefulness of Russian firms in the chaotic economic
environment.

Notes
1. The Central region consists of 13 sub-regions: Bryansk, Vladimir, Ivanovo, Kaluga, Orel,
Ryazan, Smolensk, Tula, Tver, Moscow region and Moscow (city), and is located in the
Western part of Russia, bordering Belarus and Ukraine. With a population of 29.5 million
people and an area of 483 thousand kilometers, the Central region accounts for 20 percent of
Russias total population and about 3 percent of Russias territory (Goskomstat, 1996).
JES 2. Ryterman et al. (1994) and Starodubrovskaya (1994) point out other factors contributing to
monopoly power in Russias transition economy, but for this period, concrete measures of
38,4 monopoly power are not available.
3. If firm efficiency in 1992 had an impact on privatization (that is, efficient firms privatized
first), then our regression results would be biased. We found that the firms technical
efficiency in 1992 had no effect on the probability of the firm being privatized by 1995.
448 4. Dropping firms that split or changed industry classification reduces the panel to 605 firms,
which, given the distribution across industries, would eliminate the option of examining
differences between priority and non-priority sectors. Indeed, the small sample size would
preclude analysis of power, fuel, ferrous metallurgy, chemicals, consumer goods, printing,
and construction materials.
5. That is, if the firm employs two part-time workers, where each is working one-half of the
normal work week, the firm reports a single worker. A similar calculation is made when
job-sharing includes more than two workers. In effect, this standardizes for the normal
40-hour working week. Consequently, the increasing use of part-time workers in 1995 as
compared to 1992 does not bias the results.
6. Firms retained some discretion over the capital stock actually included in the privatization
process; capital could easily disappear if it happened to benefit the strategic interests of the
firm (Filatochev et al., 1999). Moreover, the centrally determined capital revaluations that
occurred annually between 1992 and 1995 did little to link actual values to market values.
When inflation is rising rapidly, as was the case between 1992 and 1995, official indices tend
to understate actual price level changes by a significant amount. In the Russian economy,
however, where initial capital values were not determined by market forces, arbitrary
increases in the price of capital may tend to overstate its value.
7. A frontier production function is the boundary of a set of feasible combinations of inputs and
outputs, effectively defining the maximum output achievable under best-practice production
methods for a particular industry. The technical efficiency of a given firm is obtained by
measuring the distance from the firms output to the estimated production frontier of the
industry. Thus, in each industry, firms on the frontier exhibit 100 percent technical
efficiency.
8. Data envelopment analysis (DEA) is not suited for this analysis because it attributes all
errors in the production function estimation to technical inefficiency, which, given the
dramatic economic and political changes, supply disruptions, and other random shocks
associated with dismantling the planned economy, seems unrealistic. Goncharuk (2007) used
DEA to estimate technical efficiency among Ukrainian consumer goods firms, but the timing
of that study coincides with greater macroeconomic stability. For further discussion, see
Mortimer (2002).
9. We also tried CES and translog specifications. Translog functions produced results similar
to Cobb-Douglas, so we elected to use the more transparent Cobb-Douglas specification.

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Corresponding author
Susan J. Linz can be contacted at: linz@msu.edu

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