Lawless Capitalism Grips Russian Business

1
Lawless Capitalism Grips Russian Business
- The Washington PostNovember 7, 2000
2
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
3
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

4
 The Result in Russia
Broad private ownership didnt 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 didnt want a strong Securities Commission
or tighter rules on self-dealing transactions.
And what they didnt want, they didnt get.
Black et al. 2000
5
Property rights insecurity in 20 transition
economies
1.4
POL
1.2
SVN
HUN
SVK
UZB
CZE
1.0
BLR
EST
GDP 2000/GDP 1989
HRV
.8
ROM
KAZ
KGZ
BGR
LTU
RUSSIA
.6
ARM
AZE
UKR
R2 0.3452
.4
GEO
MDA
.2
80
70
60
50
40
30
20
Index of insecurity of property and contract
rights (BEEPS)
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.
6
The no-rule-of-law state
Corruption in the organs of government and
administration is literally corroding the state
body of Russia from top to bottom. Spee
ch by President Yeltsin, 1993 Russia is the
only country we know whereeven retail businesses
often operate from behind unlabeled doors
Black et al., 2000
7

• Each individual votes for the regime that
  enhances his own welfareand stripping may give
  him an interest in prolonging the absence of the
  rule of law.

8
The controllers dilemmaStrip assets or
build value
Controller
Strip assets
Build value
s(?) f ?
9
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

10
Illustration of example
Rule of law
No rule of law
Payoffs from ¼ to 1 depending on stripping
ability
Payoffs 1
11
Payoffs
x
0
1
Increasing support for the rule of law
12
Payoffs
1
1/4
x
0
1
Increasing support for the rule of law
13
Natural resource abundance, growth, and property
rights insecurity
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)
Fuel and mineral exports/ total exports 
2000 GDP/ 1989 GDP    
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  
14
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.

15
Technology and payoffs
DEPLETION OR GROWTH OF ASSET
FLOW
STRIP
16
Economic and political behavior are linked
.
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Why cant 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.

18
Dynamic model
?

x
0
1
Increasing support for the rule of law
Increasing support for the rule of law
     
19
Multiple equilibrium levels of demand for rule
of law
?
Political switch line, ?

x
 
 
0
1
Increasing support for the rule of law
     
20
Time path of expected GDP
GDP along expected growth path
time, t
21
To sum up (1) Functionalist arguments may be
misleading
1. The political environment is a public good
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And (2) the tortoise may beat the hare

• If VN 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.

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Caveats The process of legal regime transition
may not be Markov1. 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)

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2. History affects the distribution of wealth and
power Muckraking Governor Slain By Sniper
on Moscow Street Wall Street Journal, October
19, 2002
25
Future Work

• 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
Security of returns to building value
Biasedness
Oligarchy