After the Big Bang? Obstacles to the Emergence of the Rule of Law in Post-Communist Societies

When Russia launched mass privatization, it was widely believed that it would create a powerful constituency for the rule of law. That didn’t happen. We present a dynamic equilibrium model of the political demand for the rule of law and show that beneficiaries of mass privatization may fail to demand the rule of law even if it is the Pareto efficient “rule of the game.” The reason is that uncertainty about the legal regime can lead to asset stripping, and stripping can give agents an interest in prolonging the absence of the rule of law. Karla Hoff Joseph E. Stiglitz World Bank Uris Hall MC 3-301 Columbia University 1818 H St. Broadway and 116 St. Washington DC 20433 New York City, NY 10027 [email protected] [email protected] In recent years there has been a strong interest among economists in understanding the creation of the “rules of the game,” understood in the broad sense of political economy, rather than merely the behaviors of agents within a given set of rules already in place. A remarkable opportunity to observe and try to influence the creation of the rules of the game occurred with the fall of communism in Eastern Europe and the former Soviet Union in the period 1989-91. At the outset, most observers agreed that were it politically feasible to establish quickly the rule of law to underpin a market economy as or before state enterprises were privatized, it would be desirable to do so. It was, however, argued that it was politically infeasible to do so. Advocates of rapid privatization, no matter how done, said “Not to worry.” They argued that not only was an alternative reform dynamic feasible, but it would actua lly occur. Granting individuals the control of property would create a political constituency for the rule of law, where there is protection for private property rights. All over the post-communist world, Western donors promoted “Big Bang” privatization—the rapid transfer of state-owned enterprises to private economic agents (Przeworski et al. 1995, p. viii, at note 2). The paradigm that underlay this approach was articulated, for example, by Shleifer and Vishny (1998): Privatization then 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...to create market-supporting institutions...[Such] institutions would follow private property rather than the other way around.” (pp. 10-11) But there was no theory to explain how this process of institutional evolution, including a legal framework for the protection of investors, would occur and, in fact, it has not yet occurred in Russia, in other former Soviet Union countries, in the Czech Republic, and elsewhere. A central reason for that, according to many scholars, is the