“Lawless Capitalism Grips Russian Business” - The Washington Post November 7, 2000.
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Transcript of “Lawless Capitalism Grips Russian Business” - The Washington Post November 7, 2000.
“Lawless Capitalism Grips Russian Business”
- The Washington PostNovember 7, 2000
After the Big Bang?
Obstacles to the Emergence of the Rule of Lawin Post-Communist Societies
Karla Hoff and Joseph E. Stiglitz
PIEP May 2003
The Hope• “Privatization offers an enormous political
benefit for the creation of institutions supporting private property because it creates the very private owners who then begin lobbying the government...for institutions that support property rights.”
Murphy-Shleifer-Vishny 1998
Broad private ownership [didn’t create] a constituency for strengthening and enforcing [the new Civil and Commercial Codes]. Instead, company managers and kleptocrats opposed efforts to strengthen or enforce the capital market laws. They didn’t want a strong Securities Commission or tighter rules on self-dealing transactions. And what they didn’t want, they didn’t get.
Black et al. 2000
The Result in Russia
Property rights insecurity in 20 transition economies
Index of insecurity of property and contract rights (BEEPS)
GDP
200
0/G
DP 1
989
R2 = 0.3452
80706050403020
1.4
1.2
1.0
.8
.6
.4
.2
BLR
UKR
ARM
GEO
AZE
UZB
RUSSIAKAZ KGZLTU
POL
BGRROM
HRVEST
CZESVKHUN
SVN
MDA
The index of insecurity is the fraction of respondents who disagreed with the statement: “I am confident that the legal system will uphold my contract and property rights in business disputes.”
“Corruption in the organs of government and administration is literally corroding the state body of Russia from top to bottom.”
Speech by President Yeltsin, 1993
“Russia is the only country we know where…even retail businesses often operate from behind unlabeled doors
Black et al., 2000
The “no-rule-of-law state”
Question: Could individuals choose the “wrong” rules of the game?
• In choosing his economic action, each individual ignores the effect of his economic decision on how other people believe the system will evolve and, thus, how others invest and vote..
• Each individual votes for the regime that enhances his own welfare—and stripping may give him an interest in prolonging the absence of the rule of law.
The controller’s dilemma:Strip assets or build value
Strip assets
s() = f +
Controller
Build value
Rule of law
V L = f + g - IL
Political environment
No rule of law
V N = f + g - IN
Example
Stripping returns uniformly distributed on [0,1]
g – I L = 1
g – I N = ¼
= (1-x)2 Probability of rule of law = demand “squared”
Illustration of example
Payoffs from ¼ to 1 depending on stripping ability
No rule of law Rule of law
Payoffs: 1
Switch line: *= ¼ + ¾ (1-x)2
Unique stable equilibrium, probability of rule of law = 1/9
0 1x
Increasing support for the rule of law
Stripping ability curve: x = 1 -
2/3
1
1/4
Payoffs
0 1x
Increasing support for the rule of law
1
1/4
A shift up in distribution of ability to asset-strip
Initial conditions:• Criminal networks• Natural resource abundance• Civic virtue
Policy:
• Capital account convertibility
Payoffs
Natural resource abundance, growth, and property rights insecurity
Fuel and mineral exports/
total exports 2000 GDP/ 1989 GDP
Percent who believe legal system will not “uphold my contract
and property rights in business disputes”
Wall Street Journal Rule of Law index
(10 = best, 0 = worst)
Average for countries with less than 10%
natural resource exports
6.81%
89%
40%
7.5 score
Average:10 - 20%
15.22% 84% 42% 6.9 score
Average:greater than 20%
41.88%
66%
68%
4.2 score
Russia 53.15%(1996)
63% 73% 3.7 score
Legal Transition as a Markov Process
Probability of transition to rule of law depends on votes in the current period
xt vote against 1-xt vote for.
We explore a subset of possible equilibria where, as long as the no-rule-of-law prevails, the demand is the same every period.
The rule of law is an absorbing state.
Technology and payoffs
FLOWDEPLETION OR
GROWTH OF ASSET
STRIP]1[)(
,)(
fs
fsL
N 1~ z
BUILD b j = f – I j 1~ g
with 1~ gg
.
Economic and political behavior are linked
0),()( xSxV NN S w i t c h l i n e f o r b u i l d i n g v a l u e
C o n t i n u a t i o n b e n e f i t f r o m n o - r u l e - o f – l a w f o r a n a g e n t w h o s t r i p s t o d a y :
)],([ xSVz NL
)],([ pNL
p xSVz = 0 S w i t c h l i n e f o r v o t i n g
Switch line for building value vs. stripping
0),()( xSxV NN S w i t c h l i n e f o r b u i l d i n g v a l u e
C o n t i n u a t i o n b e n e f i t f r o m n o - r u l e - o f – l a w f o r a n a g e n t w h o s t r i p s t o d a y :
)],([ xSVz NL
)],([ pNL
p xSVz = 0 S w i t c h l i n e f o r v o t i n g
0),()( xSxV NN S w i t c h l i n e f o r b u i l d i n g v a l u e
C o n t i n u a t i o n b e n e f i t f r o m n o - r u l e - o f – l a w f o r a n a g e n t w h o s t r i p s t o d a y :
)],([ xSVz NL
)],([ pNL
p xSVz = 0 S w i t c h l i n e f o r v o t i n g
Why can’t society “grandfather” the control rights of the asset strippers?
Dynamic consistency problem--
The security of such rights depends on the social consensus that underlies them. Not just any distribution of property can be protected under the rule of law.
Dynamic modelθ
I (build value and support the rule of law)
θa
θp
Increasing support for the rule of law
0 1
Increasing support for the rule of law
x
III
Strip assets and oppose the rule of law
II Strip assets and support the rule of law
Multiple equilibrium levels of demand for rule
of law
Stripping ability curves
Political switch line, θ*
θ
0 1
Increasing support for the rule of law
x
High demand for the rule of law
Low demand for the rule of law
Time path of expected GDP
GDP along expected
growth path
time, t
High
Low
To sum up: (1) Functionalist arguments may be misleading
i vote
j vote
1. The political environment is a public good
2. Actions have spillover effects on the political environment
And (2) the tortoise may beat the hare
If VN < SN , there may exist an equilibrium where many strip and so many wish to prolong the no-rule-of-law state.
Big Bang privatization may thus put in place forces that delay the rule of law.
Caveats: The process of legal regime transition may not be Markov
1. History affects norms
“Vladimir Rushaylo has flatly denied the allegations that 70 per cent of all Russian officials are corrupted … ‘Only those who have links with the organized criminal gangs can be regarded as corrupted officials. Do not mistake bribe-taking for corruption,’ the Russian Interior Minister stressed. (BBC, March 13, 2001)
2. History affects the distribution of wealth and power
Muckraking Governor Slain By Sniper on Moscow StreetWall Street Journal, October 19, 2002
We made 3 very special assumptions:
• No individual agent exercises power• Only 2 possible legal regimes: one good for investment, the other bad• A fixed set of agents (no new entry)
We relax these assumptions in on-going work, where our focus is the conflict between “rules for all” (rule of law) and rules biased in favor of the powerful
Rule of law
Oligarchy
Security of returns to building value
Bia
sedn
ess
Future Work