The Corruption of Transition

A political economic framework is used to describe an economy following transition to private ownership. The transition, characterized by massive privatization, is accompanied by a constitutional change, which is influenced by potential shareholders who may be described as the local entrepreneur, the corrupt entrepreneur, or the foreign entrepreneur. The constitutional changes influence the privatization process, particularly in regards to the distribution of the firm’s residual claim and the entrepreneurs’ investment schemes. The paper sheds light on how corrupt entrepreneurs corrupt the transition. To this end, a positive model is used to characterize the political-economic equilibrium in which the constitutional change is determined, and the political and economic primitives of the model help us explain why economies perform differently after transition to private ownership. Finally, the paper identifies schemes for both international funding and domestic taxes that can help an economy support, in equilibrium, constitutional changes that are more market oriented. JEL Classification Code: Transition economies, political-economy, entrepreneurs, constitutional change, institutions, investment scheme.