Transcript PowerPoint - World Bank

“Lawless Capitalism Grips Russian Business”
- The Washington Post
November 7, 2000
After the Big Bang?
Obstacles to the Emergence of the Rule of Law
in 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
The Result in Russia
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
Property rights insecurity in
20 transition economies
1.4
POL
GDP 2000/GDP 1989
1.2
SVN
HUN
UZB
1.0
SVK
CZE
BLR
EST
HRV
.8
ROM
KAZ
BGR
.6
LTU KGZ
RUSSIA
ARM
AZE
UKR
.4
R2 = 0.3452
GEO
MDA
.2
20
30
40
50
60
70
80
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.”
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.”
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
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
Controller
Strip assets
Build value
Political environment
s() = f + 
Rule of law
V L = f + g - IL
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
No rule of law
Payoffs from ¼ to 1
depending on stripping
ability
Rule of law
Payoffs: 1
Payoffs
Unique stable equilibrium,
probability of rule of law = 1/9
1
1/
4
Switch line: *= ¼ + ¾ (1-x)2
0
2/
3
Increasing support for the rule of law
1
Stripping ability curve: x = 1 - 
x
Payoffs
A shift up in distribution of
ability to asset-strip
Initial conditions:
• Criminal networks
• Natural resource abundance
• Civic virtue
1
Policy:
• Capital account convertibility
1/
4
0
1
Increasing support for the rule of law
x
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”
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
53.15%
(1996)
63%
73%
3.7 score
Average for
countries with
less than 10%
natural resource
exports
Russia
Wall Street Journal
Rule of Law index
(10 = best,
0 = worst)
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
FLOW
STRIP
s N ( )  f   ,
DEPLETION OR
GROWTH OF
ASSET
~
z 1
s L ( )  f   [1   ]
BUILD
b j= f – I j
g~  1
~ 1
with g   g
Economic and political behavior are linked
Switch line for building value vs.
Switch line for building value
stripping
V N ( x )  S N ( x,   )  0
V N ( x )  S N ( x,   )  0
Switch line for building va
uation benefit from no-rule-of –law for an agent who strips today:
 z[V LContinuation
 S N (x, )]benefit from no-rule-of –law for an agent who strips today:
L
N
)]
 z[V L 
 S N(x,z[pV)]  S= 0(x,. Switch
line for voting
p  z[V L  S N (x, p )]
=0
Switch line for voting
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.
θ
Dynamic model
III
Strip assets and
oppose the rule of law
θp
I (build value and
support the rule of law)
II
Strip assets and
support the rule of law
θa
0
1
Increasing support for the rule of law
x
Multiple equilibrium
levels of demand for rule
of law
θ
High demand for the rule of law
Low demand for the rule of law
Political switch line, θ*
Stripping ability
curves
0
1
Increasing support for the rule of law
x
Time path of expected GDP
High 
GDP along
expected
growth path
Low 
time, t
To sum up: (1) Functionalist arguments may
be misleading
1. The political environment is a public good
2. Actions have spillover effects on the
political environment
i
vote
j
vote
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 Street
Wall Street Journal, October 19, 2002
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
Biasedness
Security of returns to
building value
Oligarchy