Janine Wedel - Collision and Collusion - The Strange Case of Western Aid to Eastern Europe

The Polish Fund was known for its profits. To bypass the $150,000-a-year salary ceiling for fund officers set by Congress, some officers devised enterprising ways to augment their salaries. In Poland, fund managers created a “clone,” the Polish Private Equity Fund, which was financed partly by foreign private investments and partly by the original Enterprise Fund. Unlike the Enterprise Fund, a share of the profits of the Equity Fund went to the managers. It made both equity and loan investments but did not take part in the fund’s small loans program, high-risk agricultural investments, or join in technical assistance efforts.28 Fund managers also discovered that one way of getting in on potentially lucrative deals was to enlist the help of former Polish government operatives. By 1994, the fund resembled a Washington revolving door, with several former high privatization officials having been hired to manage fund portfolios. The Polish Fund, unlike others in Central Europe, maintained costly executive and investment offices in the United States.29

Similarly, the Hungarian-American Enterprise Fund set up, and invested $4 million in an investment services company, nearly all of its paid-in capital, which earned some of its partners twice (or higher) the fund’s salary ceiling. This deal violated fund policies, which restricted investments to $3 million and required substantial contributions by coinvestors.30 In addition to questions about the salaries of fund partners and staff, the GAO found cases of potential conflicts of interest or the appearance thereof. For example, a Polish fund director served as president of a fund-supported foundation, as well as a professor at the university where the foundation was established. He was paid for serving in all three capacities at the same time.31

All this led to criticism that the funds, being too risk averse, failed to fulfill their primary mission of supporting small and medium-sized indigenous businesses.32 As Henryka Bochniarz, a former Polish privatization official (not working for the fund) charged: “They [the funds] want to have very good investments without headaches.… They behave like a demanding commercial institution.… This was not the idea of the Enterprise Funds.… When you talk to the [fund] people, you have the feeling that the windows program [of small loans] is totally not important.… But from the point of view of Polish society, the windows program was very important.”33

Similar views were expressed elsewhere in Central Europe. Zdeněk Drábek, former aid coordinator of Czechoslovakia, said, “The idea was that it [the fund] would go to small firms.… The reality was that it went to finance companies that had 500 to 1,000 employees.”34 When the Hungarian Fund invested in companies that had access to other sources of capital (representing 12 percent of its invested capital), the GAO questioned “whether such investments were consistent with the fund’s mandate to develop small- and medium-size businesses.” Hungarian Fund officials countered with trickle-down economics, asserting that these investments in publicly traded companies “leveraged additional investment capital by (1) encouraging other investors to invest and (2) helping to stabilize the stock market, which was not very efficient in pricing stock offerings.” Fund officials added that the investments helped to balance the portfolio and enabled the fund to invest in other, riskier businesses.35 But Zbigniew Brzezinski, a member of a board of the Polish Fund, seconded the judgment of GAO, remarking, “These funds should promote native private enterprises. They were not set up to establish foreign private investment.”36 However, compared with the development banks operating in the region, the Enterprise Funds maintained a favorable track record, as reported in a USAID-commissioned evaluation:

Enterprise funds are helping to broaden access to capital for entrepreneurs by investing in enterprises that have few alternatives. The funds have invested more than $267 million, a high percentage of which has gone to small and medium-sized enterprises. Enterprise funds are more effective at providing capital to private businesses than are other international organizations such as EBRD, World Bank, and EC Phare. Nevertheless, even under the best of circumstances, enterprise funds are able to help only a small percentage of the newly emerging private enterprises in the region.37

And, with such a large gap between the expectations created and the ultimate results, the fact that the funds failed to concentrate on small targets was not lost on the recipients, especially given the publicity the funds had generated in the host countries. As Bochniarz reported, “Today [the Polish Fund is] one of many financial institutions coming here and trying to make money. Nobody considers this part of American aid.”38

The Polish Fund’s profitability eventually created a dilemma: What to do with some $300 million (generated by fund loans and investments) left over when the fund declared its mission fulfilled and went out of business? After some controversy,39 it was decided in 1999 that $120 million would be returned to the U.S. Treasury, while the remainder would be used to set up the Polish American Freedom Foundation.40 The foundation has begun its work by subsidizing local educational programs and enterprise development projects in local communities, according to Poland’s former Ambassador to the United States and foundation president Jerzy Kozminski.41

In time, some fund-sponsored programs made important contributions. The Polish Fund pioneered mortgage banking, a form of financing previously unavailable in Poland. Aiming to encourage residential construction and home ownership, the Polish-American Mortgage Bank operated by first financing residential construction projects and later furnishing mortgage loans to buyers of the units.42 Mortgage programs are being tried in some countries further east.43

Nowhere was the tension between taking risks and playing it safe, between smaller and larger investments, more pronounced than in Russia, where the business environment generally presented tougher obstacles than in Central Europe. Robert Towbin, who served as president of the Russian-American Enterprise Fund during 18 months in 1994 and 1995, said that, when he set up the office in Russia and hired staff, he envisioned that the fund would invest in small and medium-sized companies.44 But finding such companies was not easy. Racketeers and government-favored monopolies stacked the deck against newcomers and forced many of them out of business. As Towbin put it, “You had to go out to the countryside and find investments.… That’s a lot harder than it looks.” The most successful program, in Towbin’s view, was the small-loans program, a program under which Russian banks found the client and serviced the loan, and the fund put up the money. The bank received half the interest; the fund, the other half. Most of the loans were repaid. Towbin said that “Of all the things the fund has done, the small loans program was probably the most successful.”45

However, the bulk of the fund’s lending ended up consisting of direct equity investment. In this portfolio, Towbin invested in small and medium-sized companies in basic industries such as machinery equipment, dress manufacturing, supermarkets, and finance. Each of these investments was a three- to four-year project. Towbin and other foreigners who worked successfully in the Russian environment underscored the necessity of working with such companies as partners. According to Towbin, “You’ve got to really work with companies who don’t understand the profit motive … to keep expenses down, prices up, and make up the difference in the middle. In contrast to the old days, where the more people you employed, the better you were doing,… you have to take risks and hopefully you’ll get rewards.”46