Lawless Capitalism Grips Russian Business

1
Lawless Capitalism Grips Russian Business
- The Washington PostNovember 7, 2000
2
The Creation of the Rule of Law and the
Legitimacy of Property Rights
The Political and Economic Consequences of a
Corrupt Privatization Presentation by Kar
la Hoff based on joint paper with Joseph E.
Stiglitz November 2005
3
The Questions

• What are the dynamics of the transition to the
  rule of law?
  
• What actions will expedite the process?
• Adam Smith argued that the creation at the
  end of the feudal period of opportunities to
  invest beyond ones own estate engendered a new
  set of political interests that brought about a
  slow improvement in institutions.
• Could mass privatization in transition economies
  play the same role?
  
• What effect does lack of a consensus about the
  legitimacy of property rights have? (question
  applies to Russia, Zimbabwe, and other
  post-colonial countries)

4
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

5
 The Result in Russia
Broad private ownership didnt create a consti
tuency 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
6
Distribution of transition countries and all
countries, by their World Bank rule of law
scores, 1996 and 2004.
Transition countries
.6
.6
1996
2004
Transition countries
.4
.4
kdensity rl
kdensity rl
.2
.2
World
World
0
0
-2
-1
0
1
2
-2
-1
0
1
2
Rule of law score
Rule of law score
7
The no-rule-of-law state in Russia in the 1990s
a wild market outside the law
a systemic vacuum without effective regulation
s and controls a robber-anarchical form of c
apitalism
8
Elements of a model and outline of talk Legal
Transition as a Markov Process

• 2 states of the world, rule of law (L) and
  non-rule of law (N)
  
• Probability of transition to rule of law depends
  on votes in the current period of those with
  control rights over assets
  
• xt vote against
• 1-xt vote for.
• Suppose the rule of law is pareto efficient and
  so is an absorbing state
  
• Then a path is N N N L L L LLLLLLLLLL
• The model can address the question How long
  will it take before the transition to rule of law
  (state L)?
  
• Outline of talk
• 1. Example of a static coordination game
• 2. Dynamic model, in which we consider
  equilibria in which x is the same each period as
  long as
  
• state N lasts
• 3. Limitations/extensions of the model

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1. One period coordination game
Agent
Strip assets
Build value
? (distribution of stripping
abilities among agents)
Lesson payoff from building value depends on
constituency for creation of rule of law
10

• Each individual votes his self-interest

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Example

• Stripping returns uniformly
• distributed on 0,1
• (1-x)2 Probability of rule of law
• demand squared

12
Illustration of example Payoffs under
non-rule of law state (some agents strip, others
build) and payoffs under rule of law (all agents
build)
Rule of law
No rule of law
Agents obtain payoffs from ¼ to 1 depending on
stripping ability

All agents obtain payoffs 1
13
Payoffs
x
0
1
Increasing support for the rule of law
In this ex., switch line
14
Payoffs
x
0
1
Increasing support for the rule of law
In this ex., switch line expected return from
building value
15
2. 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.
• So a path is N N L L L L L L L..

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Technology and payoffs
DEPLETION OR GROWTH OF ASSET
FLOW
q
q

STRIP
N
)
(
s
l
q
q
-

L

1

)
(
s
17
Economic and political behavior are linked
.
18
The switch lines in the non-rule-of-law state
?
II (strip assets and oppose establishment
of the rule of law)
?p(x?)
III (strip assets and demand the rule of law)
I (build value and demand the rule of law)
?a(x?)
x
0
1
Increasing opposition to the rule of law
19
The switch lines, numerical example
?
1.2
?a(x0.3)
II
1
?p(x0.3)
0.8
III
0.6
I
0.4
0.2
0
0
0.2
0.4
0.6
0.8
1
x
20
The effect on the switch lines of a fall in ?
?
1.2
?a(x0.3)
1
II
?p(x0.1)
0.8
?a(x0.1)
?p(x0.3)
0.6
III
0.4
I
0.2
0
0
0.2
0.4
0.6
0.8
1
x
21
Two stable equilibrium values of x
1.2
?a(x0.3)
1
?p(x0.3)
0.8
Stripping ability curve
0.6
0.4
?a(x0.3)
0.2
0
x0.75
x0
22
Two stable equilibrium paths of agents
aggregate expected income
2.5
2.0
x 0
1.5
Agents' aggregate expected income
1.0
x 0.75
0.5
0
0
10
20
30
40
50
60
70
80
Time period
23
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.

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? 0 (no reappropriation of stripping returns)
?
1.2
II
1
?p(x0)
?max
0.8
III
0.6
I
0.4
0.2
?a(x0)
0
0
0.2
0.4
0.6
0.8
1
x
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. Presence of a minority of agents for whom
stripping always dominates building value will
amplify the coordination problem among agents for
whom rule of law is the pareto efficient state
?
1.2
Stripping ability curve 2
1
?a(x0.3)
?p(x0.3)
0.8
Stripping ability curve 1
0.6
0.4
0.2
0
x0.85
0
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To sum up Functionalist arguments may be
misleading
1. The political environment is a public good
27
Trade-offs in the choice of reform sequences
Decay of stateassets
Y constant
Big bang is preferred
Gradualism is preferred
Leftward shift in stripping ability curve
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3. Caveats The process of legal regime
transition may not be Markov 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)

29
History affects the distribution of wealth and
power Muckraking Governor Slain By Snipe
r on Moscow Street Wall Street Journal, Octob
er 19, 2002
30
Conclusion Coasian view (what matters is
defining property rights) is misleading, because
it ignores the problem of corporate governance
(the control function in corporations is not
allocated on the basis of property rights) and
the resulting scope for theft

• In Russia, privatization occurred prior to the
  creation of the rule of lawor of a government
  with political legitimacyand the long run
  prospects of rule of law may have been
  undermined
• Similar problems of legitimacy and rule of law
  have bedeviled countries where a legacy of
  colonial rule is a set of weak and conflicting
  property rights institutions and patterns of
  authority

31
Zimbabwe2000 When land-hungry citizens in Zimb
abwe seized control of large, privately owned,
commercial farms in 2000, the courts and the
international media interpreted this as a
battle over the rule of law, but the crisis
quickly expanded to a debate over the history of
racial domination and the legitimacy of inherited
laws and institutionsResponding to international
pressure that land reform must proceed within the
law, Zimbabwean activists and intellectuals
replied that the distribution of property rights
was an artifact of colonial ruleToday, they
point out, it is illegal in Zimbabwe to possess
stolen property. So who is subverting the rule
of law?