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Economists conventionally treat an individuals political interests as
Economists conventionally treat an individuals political interests as
Lawless Capitalism Grips Russian Business
Lawless Capitalism Grips Russian Business
After the Big Bang: Obstacles to the Emergence of the Rule of Law in
After the Big Bang: Obstacles to the Emergence of the Rule of Law in
The Hope
The Hope
The Result in Russia
The Result in Russia
Central Argument
Central Argument
What I am going to talk about
What I am going to talk about
I. Timeline for Russia
I. Timeline for Russia
Growth and property rights insecurity in 20 transition economies
Growth and property rights insecurity in 20 transition economies
The no-rule-of-law state
The no-rule-of-law state
Each individual votes for the regime that enhances his own welfareand
Each individual votes for the regime that enhances his own welfareand
II
II
I. Static model: The controllers dilemma strip assets of build value
I. Static model: The controllers dilemma strip assets of build value
Notation
Notation
Equilibrium
Equilibrium
Dual stable equilibria
Dual stable equilibria
Example
Example
Rule of law is the Pareto efficient rule of the game Will agents
Rule of law is the Pareto efficient rule of the game Will agents
Payoffs
Payoffs
Payoffs
Payoffs
Natural resource abundance, growth, and property rights insecurity
Natural resource abundance, growth, and property rights insecurity
Payoffs
Payoffs
Payoffs
Payoffs
III
III
Transition to the Rule of Law as a Markov Process
Transition to the Rule of Law as a Markov Process
Technology and payoffs
Technology and payoffs
Majority prefers building value under the rule of law to stripping
Majority prefers building value under the rule of law to stripping
Two more value functions
Two more value functions
Economic and Political Behavior
Economic and Political Behavior
Why cant society grandfather the control rights of the asset
Why cant society grandfather the control rights of the asset
Dynamic model
Dynamic model
Multiple equilibrium levels of demand for rule of law
Multiple equilibrium levels of demand for rule of law
Time path of expected GDP
Time path of expected GDP
Summary of model: A tale of two distortions
Summary of model: A tale of two distortions
Rapid privatization: neither a cul de sac nor a sure way to create a
Rapid privatization: neither a cul de sac nor a sure way to create a
And (2) the tortoise may beat the hare
And (2) the tortoise may beat the hare
Caveats: The actual process of legal regime transition is not Markov 1
Caveats: The actual process of legal regime transition is not Markov 1
2. History affects the distribution of wealth and power Muckraking
2. History affects the distribution of wealth and power Muckraking
Future Work
Future Work

: Economists conventionally treat an individuals political interests as determined by his preferences and endowments. : pmeans. : Economists conventionally treat an individuals political interests as determined by his preferences and endowments.ppt. zip-: 154 .

Economists conventionally treat an individuals political interests as determined by his preferences and endowments

Economists conventionally treat an individuals political interests as determined by his preferences and endowments.ppt
1 Economists conventionally treat an individuals political interests as

Economists conventionally treat an individuals political interests as

determined by his preferences and endowments. For many purposes, thats a useful approach. But for other purposes, it may not be. In particular, in the case of large-scale institutional change, each individuals own political interests may depend on the behaviors of others. Issues of coordination arise. In that case, we need to consider the equilibrium set of individuals economic actions and political positions. This paper tries to do that. The paper is motivated by a particular puzzlethe weak demand for the rule of law in Russia, the Czech Republic, and other countries of the former Soviet empire. But the paper also applies more generally to economies with weak institutions and with assets to steal. In this broader context, the paper can be thought of as a theory of anarchy.

2 Lawless Capitalism Grips Russian Business

Lawless Capitalism Grips Russian Business

- The Washington Post November 7, 2000

3 After the Big Bang: Obstacles to the Emergence of the Rule of Law in

After the Big Bang: Obstacles to the Emergence of the Rule of Law in

Post-Communist Societies Karla Hoff and Joseph E. Stiglitz September 2003

4 The Hope

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

The Result in Russia

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

6 Central Argument

Central Argument

Individuals choose the rules of the game in an incomplete market setting. Actions have externalities mediated through the political environment. which ? May lead agents to take actions that give them an (ex post) interest in prolonging the no-rule-of-law statean effect that isnt internalized because the rule of law is a public good.

7 What I am going to talk about

What I am going to talk about

I. Overview of Russian privatization II. Static model of the demand for the rule of law (coordination game) III. Infinite period model (Markov)

8 I. Timeline for Russia

I. Timeline for Russia

planning for mass privatization 1991 dissolution of USSR 1992 Big Bang voucher privatization starts 1994 14,000 medium & large enterprises privatized 70% insiders 14% outsiders 16% government 1995 Loans for Shares 1995-2001 Massive capital flight ~$15 - $20 billion per year

9 Growth and property rights insecurity in 20 transition economies

Growth and property rights insecurity in 20 transition economies

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.

GDP 2000/GDP 1989

Index of insecurity of property and contract rights (BEEPS)

1.4

1.2

1.0

.8

.6

R2 = 0.3452

.4

.2

20

30

40

50

60

70

80

POL

SVN

HUN

SVK

UZB

CZE

BLR

EST

HRV

ROM

KAZ

KGZ

BGR

LTU

RUSSIA

ARM

AZE

UKR

GEO

MDA

10 The no-rule-of-law state

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 whereeven retail businesses often operate from behind unlabeled doors Black et al., 2000

11 Each individual votes for the regime that enhances his own welfareand

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.

12 II

II

Static Model

Agents A fixed set of agents have control rights Agents differ in their ability to strip, ? They seek to maximize expected wealth.

13 I. Static model: The controllers dilemma strip assets of build value

I. Static model: The controllers dilemma strip assets of build value

14 Notation

Notation

? = probability that the rule of law is enacted x = fraction of agents who strip assets ? = ? (x) a decreasing function

15 Equilibrium

Equilibrium

?* = g - ?(x) I L - [1-?(x)] I N Switch line Agents with a comparative advantage in stripping assets relative to ?* (i.e., ? > ?*) will choose to strip assets and thus x = 1 H(?*) Stripping ability curve

16 Dual stable equilibria

Dual stable equilibria

Payoffs

1

17 Example

Example

? = (1-x)2 , ? is uniformly distributed on [0,1], g I L = 1 g I N = ?.

18 Rule of law is the Pareto efficient rule of the game Will agents

Rule of law is the Pareto efficient rule of the game Will agents

vote for it?

OR

?

Rule of law

No rule of law

Payoffs from ? to 1 depending on stripping ability

Payoffs: 1

19 Payoffs

Payoffs

x

0

1

Increasing support for the rule of law

20 Payoffs

Payoffs

1

1/4

x

0

1

Increasing support for the rule of law

21 Natural resource abundance, growth, and property rights insecurity

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

22 Payoffs

Payoffs

1

1/4

x

2/3

0

1

Increasing support for the rule of law

23 Payoffs

Payoffs

1

1/4

x

2/3

0

1

Increasing support for the rule of law

24 III

III

Dynamic extension of the model

But let them stealThey will then become owners and decent administrators of their property. (Chubais, quoted in Freeland, 2000) Agents live forever. In each period: Stage 1. Agents observe the current state (N or L) and choose an action to build value or strip and a political position for or against the rule of law. Stage 2. The new state (N or L) is realized, and agents receive state-contingent returns.

25 Transition to the Rule of Law as a Markov Process

Transition to the Rule of Law as a Markov Process

The probability of transition from the no-rule-of law regime to the rule of law depends on the level of support in the current period: ?t = ? (xt) The rule of law is an absorbing state. We explore a subset of possible equilibria where, as long as the no-rule-of-law prevails, the level of support is the same in each period.

26 Technology and payoffs

Technology and payoffs

DEPLETION OR GROWTH OF ASSET

FLOW

STRIP

27 Majority prefers building value under the rule of law to stripping

Majority prefers building value under the rule of law to stripping

under no rule of law

In the rule-of-law state, ALL prefer to build:

28 Two more value functions

Two more value functions

1st term: asset value if current expected flows continued forever

2nd term: capital gain or loss from the transition to the rule of law.

29 Economic and Political Behavior

Economic and Political Behavior

.

30 Why cant society grandfather the control rights of the asset

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.

31 Dynamic model

Dynamic model

?

x

0

1

Increasing support for the rule of law

Increasing support for the rule of law

32 Multiple equilibrium levels of demand for rule of law

Multiple equilibrium levels of demand for rule of law

?

Political switch line, ?*

x

0

1

Increasing support for the rule of law

33 Time path of expected GDP

Time path of expected GDP

GDP along expected growth path

time, t

34 Summary of model: A tale of two distortions

Summary of model: A tale of two distortions

1. Externalities from actions (stripping or building value ) on the political and legal environment

35 Rapid privatization: neither a cul de sac nor a sure way to create a

Rapid privatization: neither a cul de sac nor a sure way to create a

demand for law

Under the no-rule-of-law state, some agents strip assets (since VN < SN ) ? which gives them an interest in prolonging the no-rule-of-law state ? weakening the constituency for the rule of law ? criminal capitalism . Under the rule of law, agents choose to build value (since VL > SL) ? which ensures a constituency for rule of law ? beneficent capitalism.

36 And (2) the tortoise may beat the hare

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 put in place forces that delay the rule of law.

37 Caveats: The actual process of legal regime transition is not Markov 1

Caveats: The actual process of legal regime transition is not 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)

38 2. History affects the distribution of wealth and power Muckraking

2. History affects the distribution of wealth and power Muckraking

Governor Slain By Sniper on Moscow Street Wall Street Journal, October 19, 2002

39 Future Work

Future Work

Here 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

Economists conventionally treat an individuals political interests as determined by his preferences and endowments
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